The mean‐variance paradigm has the strong implication that all investors should hold risky assets in the same proportion. Financial planners typically advise conservative investors to tilt their risky portfolios towards bonds and away from stocks; this has been called the “asset allocation puzzle” since it contradicts standard mean‐variance analysis. Financial planners also argue that long‐term investors can afford greater exposure to stock market risk. This book will show how financial planners’ advice can be justified by an inter‐temporal model of a rational investor. The model ignores some important real‐world issues, including diversification of individual stocks, transactions costs, taxation, and the biases identified by research in behavioural finance.
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