Incorporating Time into the Efficient Frontier

Blanchett, David M.
May 2011
Journal of Financial Planning;May2011, Vol. 24 Issue 5, p51
Academic Journal
• The portfolio construction process has historically yielded a two- dimensional output, where the efficiency of a portfolio is determined based on its return and the standard deviation. Risk is usually defined as standard deviation and based on a single holding period: annually. This approach to portfolio construction ignores the fact that investors have varied investing time frames. • This research will demonstrate that the relative efficiency of a portfolio changes over various holding periods, and that by adding a third dimension to the optimization process-time- you can create portfolios that are more efficient given an investor's expected holding period. • An approach is introduced to incorporate time into the efficient frontier, which allows the user to easily adjust the input parameters for mean-variance optimization (MVO) through the use of a simple "time decay" factor. • This approach has practical implications when building portfolios, such as determining the allocations in a "bucket" portfolio and determining the equity glide path for a target- date portfolio.


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