This paper considers dynamic asset allocation in a mean versus downside-risk framework. We derive closed-form solutions for the optimal portfolio weights when returns are lognormally distributed. Moreover, we study the impact of skewed and fat-tailed return distributions. We find that the optimal fraction invested in stocks is V-shaped: at low and high levels of wealth the investor increases the stock weight. The optimal strategy also exhibits reverse time-effects: the investor allocates more to stocks as the horizon approaches. Furthermore, the investment strategy becomes more risky for negatively skewed and fat-tailed return distributions.

Econometric Institute Research Papers
Erasmus School of Economics

Berkelaar, A., & Kouwenberg, R. (2000). Dynamic asset allocation and downside-risk aversion (No. EI 2000-12/A). Econometric Institute Research Papers. Retrieved from