Optimal growth portfolios reconciling theory and practice

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.