Inter-Temporal Optimal Asset Allocation and Time-Varying Risk Aversion

Abstract

The inter-temporal optimal decision is related to investors risk preferenc e. In this study, we analyze the optimal asset allocation over investment horizon of invariable risk preference indicate d by constant risk aversion. To capture dynamic property of risk aversion, we relax the assumption of constant risk aversion and formulate a time-varying function in response to the impacts of time and wealth. Our general decision model built on time-varying risk aversion allows us to further investigate the inter-temporal optimal asset allocation. The numerical evidences from the model show that the optimal allocation of risky assets in portfolios is significantly related to investors risk aversion and that the time diversification is not exis ted under the time-varying risk aversion.