Abstract
For investors who are more risk averse than the representative investor, the horizon effect in dynamic asset allocation is substantially larger than suggested in previous models that assume a constant risk-free rate. The illustrations here use a market setting with a representative investor who has a multiperiod horizon and a constant degree of relative risk aversion. If the market portfolio is mean-reverting, then the risk-free rate is not constant, and the market risk premium reflects the Merton intertemporal risk of unexpected changes in the market portfolio’s expected return.
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