TIME DIVERSIFICATION: AN ESSAY ON THE NEED TO REVISIT FINANCE THEORY

Abstract

In 1985 Findlay and Williams offered a cogent critique of mainstream finance theory and of the need to revisit its framework of assumptions. They argued that the assumptions of the mainstream finance theory are manifestly contradicted by observation. They further contended that in the field of finance the basic positivist notion that ”assumptions do not matter if the model works” has been subverted into the notion that “assumptions cannot be criticised so long as the model cannot be shown not to work”. They predicted that since many models cannot be rejected, this posture could only lead to intellectual stalemate between supporters of opposing models. In spite of this prediction they offered no concrete examples of the types of stalemate that might develop; instead they addressed the whole field of finance and consequently their criticisms and recommendations were very general in nature.$PThe purpose of this essay is to provide a detailed analysis of the specific issue of time diversification in investment as an example of an intellectual stalemate between prominent academics employing the mainstream approach to finance theory and the majority of investment practitioners. The intention is to use this example as an illustration of the need to revisit the arguments of Findlay and Williams and the underlying framework of mainstream finance theory. In conclusion, in the spirit of Findlay and Williams, the important example of time diversification offers firm evidence of the need to revisit finance theory and to adopt a more behavioural stance towards its development.