TY - JOUR
T1 - Mean-Variance Analysis, the Geometric Mean, and Horizon Mismatch
AU - Levy, Haim
N1 - Publisher Copyright:
© 2024 Portfolio Management Research. All rights reserved.
PY - 2024
Y1 - 2024
N2 - The investment horizon plays a crucial role in portfolio selection: For horizons approximately up to a year, one can safely employ the mean-variance (M-V) rule. Moreover, if investment consultants use monthly rates of return to derive the M-V efficient set and the investor horizon is longer but smaller than one year, the economic cost induced by this horizon mismatch is negligible. For longer horizons, the M-V rule deviates substantially from expected utility maximization and the economic cost induced by employing the M-V rule is substantial. For relatively long horizons (say 20 or 30 years), despite the argument that with myopic preference the horizon does not matter, small stocks dominate large stocks by the maximum geometric mean (MGM) rule and, in practice, also by expected utility for all economically relevant preferences, as there is almost first-degree stochastic dominance (AFSD).
AB - The investment horizon plays a crucial role in portfolio selection: For horizons approximately up to a year, one can safely employ the mean-variance (M-V) rule. Moreover, if investment consultants use monthly rates of return to derive the M-V efficient set and the investor horizon is longer but smaller than one year, the economic cost induced by this horizon mismatch is negligible. For longer horizons, the M-V rule deviates substantially from expected utility maximization and the economic cost induced by employing the M-V rule is substantial. For relatively long horizons (say 20 or 30 years), despite the argument that with myopic preference the horizon does not matter, small stocks dominate large stocks by the maximum geometric mean (MGM) rule and, in practice, also by expected utility for all economically relevant preferences, as there is almost first-degree stochastic dominance (AFSD).
UR - http://www.scopus.com/inward/record.url?scp=85198232702&partnerID=8YFLogxK
U2 - 10.3905/jpm.2024.50.8.161
DO - 10.3905/jpm.2024.50.8.161
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AN - SCOPUS:85198232702
SN - 0095-4918
VL - 50
SP - 161
EP - 181
JO - Journal of Portfolio Management
JF - Journal of Portfolio Management
IS - 8
ER -