Title: Prospective utility and time-varying optimal asset allocation for the UK: 1803-1995

Authors: Ian McManus, Owain Ap Gwilym, Stephen Thomas

Addresses: School of Management, University of Southampton, Southampton, SO17 1BJ, UK. ' Bangor Business School, Bangor University, Gwynedd, LL57 2DG, Wales, UK. ' Cass Business School, City University, Bunhill Row, London, UK

Abstract: The equity risk premium has attracted considerable debate and various proposed explanations. We re-examine one approach based on myopic loss aversion, while incorporating time variation in returns distributions. We identify optimal asset allocations across a two-century period for the UK, in the context of a range of plausible investment evaluation periods. We demonstrate that both the frequency of evaluation which achieves indifference between equities and bonds, and the optimal asset allocation profile, vary significantly over time. Although equities dominate for long periods, it is evident that periods of low inflation lead to the prominence of bonds in optimal allocations.

Keywords: prospective utility; asset allocation; equity risk premium; behavioural finance; UK; United Kingdom; myopic loss aversion; time variation; returns distributions; investment evaluation; equities; bonds.

DOI: 10.1504/IJBAF.2009.027447

International Journal of Behavioural Accounting and Finance, 2009 Vol.1 No.2, pp.95 - 110

Published online: 25 Jul 2009 *

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