Investing for the Short and the Long Term

If asset returns have different dynamics, then their short and long run risk characteristics differ. For instance, if returns on one asset follow a random walk, it is very risky to hold for the long term even if it is quite safe for the short term. This paper examines the effects of different returns dynamics of assets on optimal portfolio behavior, for Portfolios held for differing lengths of times. It then examines the evidence on the dynamics of stock and bill returns in the United States. The evidence is that bill returns are more highly serially correlated than stock returns. Thus their riskiness relative to that of stocks rises the longer they are held. optimal portfolios are simulated, and it is shown that optimal port- folio proportions are not very sensitive to the length of the holding period of the portfolio.