Springer Nature is making SARS-CoV-2 and COVID-19 research free. View research | View latest news | Sign up for updates

Optimal growth portfolios reconciling theory and practice

  • 64 Accesses

  • 2 Citations

Abstract

Modern portfolio theory dictates diversification among assets that are not perfectly correlated (that is, asset diversification). Professional investors, on the other hand, contend that one can simply diversify across time (that is, time diversification). The controversy of time diversification versus asset diversification is examined in this article by empirically analyzing the optimum investment strategies for a myopic utility function (the extreme case that supports across asset diversification) under varying degrees of relative risk aversion. While Merton and Samuelson (1974) and Samuelson (1990) show that with a myopic utility function the investment diversification strategy does not change with an increase in the investment horizon, the recommendation of professional investors is also found to hold since for a wide range of relative risk-aversion measures, the optimum portfolio is shown to consist almost entirely of equities.

This is a preview of subscription content, log in to check access.

References

  1. BerimanL., “Optimal Gambling System for Favorable Games.” Proceedings of the Fourth Berkeley Symposium on Mathematical Statistics and Probability Berkeley: University of California Press, 1, 63–68, (1961).

  2. FriendJ., and M.Blume, “The Demand for Risky Assets.” American Economic Review, 31(5), 900–922, (December 1975).

  3. GrauerR. R. and N. H.Hakansson, “Gains From International Diversification: 1968–85 Returns on Portfolios of Stocks and Bonds.” Journal of Finance, 42, (3), 721–739, (1987).

  4. GrauerR. R., and N. H.Hakansson, “Higher Return, Lower Risk and Historical Returns on Long-Run, Actively Managed Portfolios of Stocks, Bonds, and Bills: 1936–1978.” Financial Analysts' Journal 38, 39–53, (March–April 1982).

  5. Grauer, R. R., and N. H. Hakansson, “Returns on Levered, Actively Managed, Long-Run Portfolios of Stocks, Bonds, and Bills, 1934–1983.” Financial Analysts' Journal, 24–43, (September–October 1985).

  6. GrauerR. R., and N. H.Hakansson, “A Half Century of Returns on Levered and Unlevered Portfolios of Stocks, Bonds, and Bills, with and Without Small Stocks.” Journal of Business 59 (2), 287–318, (1986).

  7. GrauerR. R., and N. H.Hakansson, “Industry Rotation In the United States Stock-Market: 1934–86 Returns on Passive, Semipassive, and Active Strategies.” Journal of Banking and Finance 14 (2–3), 513–538 (1990).

  8. Hakansson, Nils, “Capital Growth and the Mean-Variance Approach to Portfolio Selection.” Journal of Financial and Quantitative Analysis, 517–557, (January 1971).

  9. Hakansson, Nils, “Optimal Multi-period Portfolio Policies.” In E. Elton and M. J. Gruber (eds.), Portfolio Theory, TIMS Studies in the Management Science, 11. North-Holland, 6(1), 1979.

  10. KellyJ., “A New Interpretation of Information Rate. Bell System Technology Journal, 35, 917–926, (1956).

  11. Lee, Wayne Y., “Diversification and Time: Do Investment Horizons Matter?” Journal of Portfolio Management, 21–26, (Spring 1990).

  12. LevhariDavid, and H.Levy, “The Capital Asset Pricing Model and the Investment Horizon.” Review of Economics and Statistics 59, 92–104, (February 1977).

  13. LevyHaim, “Measuring Risk and Performance Over Alternative Investment Horizons” Financial Analysts Journal, 40(2), 61–67, (March–April 1989).

  14. LevyHaim, “Stochastic Dominance, Efficiency Criteria, and Efficient Portfolios: The Multiperiod Case.” American Economic Review 63, 986–994, (1973).

  15. LevyHaim, “Portfolio Performance and the Investment Horizon” Management Science 18, 645–653, (August 1972).

  16. MacLeanL. C., W. T.Ziemba, and G.Blazenko, “Growth Versus Security in Dynamic Investment Analysis.” Management Science, 38(11), 1562–1585, (November 1993).

  17. MarkowitzHarry M., Donald W.Reid, and Bernard V.Tew, “The Value of a Blank Check.” Journal of Portfolio Management, 20(4), 82–91, (Summer 1994).

  18. MertonR., and P. A.Samuelson, “Fallacy of the Lognormal Approximation of Optimal Portfolio Decision Making over Many Periods.” Journal of Financial Economics 1, 67–94, (1974).

  19. MulveyJohn M., “Multivariate Stratified Sampling by Optimization.” Management Science 29(6), 715–724, (June 1983).

  20. Samuelson, P. A., “Asset Allocation Could be Dangerous to Your Health.” Journal of Portfolio Management, 5–8, (Spring 1990).

  21. SharpeW. F., “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk.” Journal of Finance, 19, 425–442, (1964).

  22. ThorpE. O., “Portfolio Choice and the Kelly Criterion,” In W. T.Ziemba and R. G.Vickson (eds.), Stochastic Optimization Models in Finance, New York: Academic Press, 1975.

  23. TobinJ., “The Theory of Portfolio Selection.” in F. H.Hahn and F. P. R.Brechling, (eds.), The Theory of Interest Rates, London; Macmillan, 1965.

Download references

Author information

Rights and permissions

Reprints and Permissions

About this article

Cite this article

Gunthorpe, D., Levy, A. Optimal growth portfolios reconciling theory and practice. Rev Quant Finan Acc 7, 177–186 (1996). https://doi.org/10.1007/BF00243977

Download citation

Key words

  • asset diversification
  • time diversification
  • myopic utility functions