A Simple Framework for Time Diversification

Abstract

In this article the authors provide a simple but rigorous mathematical framework for time diversification. Based on this framework, we provide a measure of time diversification that can be computed for any return distribution model and any risk measure; this measure of time diversification can be empirically ascertained with non-parametric estimates of risk and with bootstrap techniques to simulate the return distribution. The authors argue that the critical issue of time diversification is not how to interpret time diversification in sequences of IID returns, but how to make long-term forecasts. The latter involves complex issues related to the distributional properties of returns, as well as memory effects and regime shifts. The authors then discuss how the distributional properties of stock returns, long memory, and regime shifts affect time diversification. <b>TOPICS:</b>Volatility measures, portfolio management/multi-asset allocation