Commitment Driven Investing and Time Diversification

Abstract

Contrary to conventional practices, classic works of P. Samuelson and R. Merton demonstrated the rationality of the myopic view of life-cycle portfolio selection - a rational investor should maintain the same portfolio regardless of the investor’s age. Since then, academic and practitioners have endeavored to find a sensible portfolio selection framework that would justify the rationality of evolving portfolios. This paper provides such a framework as well as theoretical justification for the conventional practices - an investor’s portfolio should be rationally expected to evolve as the investor gets older. This framework differs from the classic approach in its primary objective (to fund a specific financial commitment vs. to maximize expected utility) as well as in the recognition that multiple asset allocation decisions should form a Nash equilibrium solution to the problem of funding the commitment.