The Time-Diversification Controversy

Abstract

Some financial theorists reject the widely held practitioner belief in time diversification. The theorists argue that, given serially uncorrelated returns, holding a risky asset over longer periods of time will not reduce its inherent riskiness. The argument is supported by references to economic models of risk aversion, such as mean–variance optimization and expected utility theory. Mean–variance optimizers, however, are not indifferent to investment horizon, and investment horizon indifference is only a special case within expected utility theory. Furthermore, to the extent that models reject the notion of time diversification, they are inadequate because they are inconsistent with common sense measures of risk at very long horizons.