Beyond Diversification: What Every Investor Needs to Know About Asset Allocation

8

Longer-Term Risk Forecasting and Something About Dilequants

When we use standard deviation as our measure of risk, we assume that returns are normally distributed, which is not always the case, and we assume that investors follow a peculiar decision process.

—JPP

PREVIOUS RESEARCH ON MANAGED VOLATILITY AND covered call writing and Poon and Granger’s review of 93 papers on risk forecasting—the mega, multiauthor horse race I mentioned in my introduction to this risk forecasting—all focus on short-term risk forecasts, mostly between one-hour and one-month horizons. For strategic asset allocation and many tactical asset allocation processes, these forecast horizons aren’t long enough.

There also appears to be an unspoken assumption among the ...