AllAboutAlpha | Apr 16, 2013 01:41AM ET
A “glide path” seems like such a comforting metaphor within the otherwise abstract and sometimes confusing terminology of investments, traditional or alternative. “Glide path” suggests that the possession of enough money for the serene enjoyment of one’s golden years is a matter of arranging a slow and untroubled descent onto the tarmac of an airport.
A new study, produced as part of the BNP Paribas Investment Partners research chair on at EDHEC-Risk Institute, looks into asset-liability management from the point of view of the control of both short-term loss aversion and longer-horizon risk aversion. Its key point is that those are two different things, and that failure to distinguish between them can lead to significant opportunity costs. Along the way, it picks something of a quarrel with advocates of glide-path portfolios.
The cost of insuring against threats lessens as the time horizon becomes more myopic. Consider the goal of assuring the owner of a portfolio that his wealth shall not fall below a certain specified floor. This is the task illustrated by the two panels below, taken from the report. The top panel shows the costs of optimal insurance as a function of risk aversion (and on three different assumptions as to initial wealth and ‘floor,’ coded by color) given a 10 year horizon. The bottom panel shows the same three lines, given a 20 year horizon. The lowering of all the curves is consistent and dramatic.
Figure 1: Cost of Optimally Managing the Insurance as a function of the Risk Aversion
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