Differences Between Short- and Long-Term Risk Aversion: An Optimal Asset Allocation Perspective

Abstract

This paper studies the long-term asset allocation problem of an investor with different risk aversion attitudes to the short and the long term. We characterize investor's preferences with a utility function exhibiting a regime shift in risk aversion at some point of the multiperiod investment horizon that is estimated using threshold nonlinearity methods. Our empirical results for a portfolio of cash, bonds and stocks suggest that long-term risk aversion is higher than short-term risk aversion and increases with the investment horizon. The exposure of the investment portfolio from stocks to bonds and cash increases with the degree of risk aversion.