Abstract

http://ssrn.com/abstract=1687272
 
 

References (34)



 


 



Diversification Across Time


Ian Ayres


Yale University - Yale Law School; Yale University - Yale School of Management

Barry J. Nalebuff


Yale University - Yale School of Management

October 4, 2010

Yale Law & Economics Research Paper No. 413

Abstract:     
By employing leverage to gain more exposure to stocks when young, individuals can achieve better diversification across time. Using stock data going back to 1871, we show that early leverage combined with reduced equity exposure when older can reduce lifetime portfolio risk. For example, an initially-leveraged portfolio can produce the same mean accumulation as a constant 75% stock allocation with a 21% smaller standard deviation. Since the mean accumulation is the same, the reduction in volatility does not depend on the equity premium. A leveraged lifecycle strategy can also allow investors to come closer to their utility-maximizing allocation. If risk preferences would lead an investor to allocate 50% of his discounted retirement savings to stocks, that would require a young investor to put well more than 50% of his liquid savings into stocks. We employ leverage (limited to 2:1) to help the investor overcome a limited ability to borrow against human capital. Based on historical returns, we find a 37% improvement in the certainty equivalent (for CRRA=4). Monte Carlo simulations show that these gains continue even with equity premia well below the historical average.

Number of Pages in PDF File: 34

Keywords: Diversification, Leverage, Retirement, Investment Strategy

JEL Classification: D31, G1, G11, G18, H5

working papers series


Download This Paper

Date posted: October 5, 2010 ; Last revised: November 5, 2010

Suggested Citation

Ayres, Ian and Nalebuff, Barry J., Diversification Across Time (October 4, 2010). Yale Law & Economics Research Paper No. 413. Available at SSRN: http://ssrn.com/abstract=1687272 or http://dx.doi.org/10.2139/ssrn.1687272

Contact Information

Ian Ayres (Contact Author)
Yale University - Yale Law School ( email )
P.O. Box 208215
New Haven, CT 06520-8215
United States
203-432-7101 (Phone)
203-432-2592 (Fax)
Yale University - Yale School of Management
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
Barry Nalebuff
Yale University - Yale School of Management ( email )
135 Prospect Street
P.O. Box 208200
New Haven, CT 06520-8200
United States
203-432-5968 (Phone)
203-432-6974 (Fax)
Feedback to SSRN


Paper statistics
Abstract Views: 1,554
Downloads: 338
Download Rank: 48,883
References:  34

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo3 in 0.344 seconds