FIN-01-067

Risk Aversion and Allocation to Long-Term Bonds

November, 2001

Jessica A. Wachter

ABSTRACT

As risk aversion approaches infinity, the portfolio of an investor with utility over consumption at time T is shown to converge to the portfolio consisting entirely of a bond maturing at time T. Previous work on bond allocation requires a specific model for equities, the term structure, and the investor's utility function. In contrast, the only substantive assumption required for the analysis in this paper is that markets are complete. The result, which holds regardless of the underlying investment opportunities and the utility function, formalizes the "preferred habitat" intuition of Modigliani and Sutch.

Jessica A. Wachter
Institution: Stern School of Business, New York University, 44th West 4th Street, New York, NY 10012
Telephone: (212) 998-0799
Fax: 212) 995-4233
Email: jwachter@stern.nyu.edu
Homepage:http://www.stern.nyu.edu/~jwachter/

To download a copy of this paper click here
To request a copy of this paper click here

The Finance Department Working Paper Series has been generously sponsored by