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Time diversification under loss aversion: a bootstrap analysis

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We examine the problem of time diversification from the viewpoint of prospect theory investors. We use a block bootstrap approach to generate returns of US stocks and Treasury bills for time horizons ranging from 1 year to 20 years. On average, value functions computed using these bootstrapped returns are mainly positive and increase monotonically with the time horizon. The strategy that yields the highest average value function is the one that buys and holds an all-equity portfolio for 20 years. In contrast, mean-variance optimal portfolios are more conservative, with the optimal proportion of the portfolio invested in stocks declining with time horizon. Our results suggest that time diversification ought to be viewed more favourably by prospect theory investors than by mean-variance investors.

Keywords: C15; G11; bootstrap; loss aversion; prospect theory; time diversification

Document Type: Research Article

DOI: http://dx.doi.org/10.1080/00036846.2011.608643

Affiliations: Department of Finance,NUS Business School, National University of Singapore, Kent Ridge CrescentSingapore 119245, Singapore

Publication date: February 1, 2013

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