Optimal Decision-Making with Time Diversification

Abstract

One of the most enduring topics in financial theory is the persistence of investment risk across time. Traditional finance lacks methods for considering and hedging non-diversifiable risks. This paper is based on the general equilibrium model of Allen and Gale (1997). We extend their model in various directions: the intermediary is a firm and not a planner, financial markets are assumed to be incomplete, and the mechanism of intergenerational risk-sharing is endogenously determined. Our model allows for the analysis of optimal behavior of individuals and the intermediary together with the respective feedback processes.

Keywords: Cross-Sectional Risk, Intertemporal Risk-Smoothing, Risk-Sharing, Time Diversification and Incomplete Financial Markets

JEL Classification: G10, G20, D91