TIME DIVERSIFICATION AND OPTION PRICING THEORY - ANOTHER PERSPECTIVE - OPTION PRICING THEORY CANNOT CONTRIBUTE TO THE INVESTOR HORIZON PROBLEM

In a recent article, Craig Merrill and Steven Thorley used option pric ing theory to provide objective evidence that longer time horizons red uce the risk of equity investments. Analyzing financially engineered s ecurities that guarantee a minimum return, they show that the cost of risk elimination decreases with longer time horizons. In this article, the authors use these securities to compare strategies that repeatedl y guarantee a minimum return over a short horizon to those that give a single guarantee over a long horizon. They find that neither strategy is dominating, which becomes even more evident in a risk-neutral worl d. The authors conclude that the time diversification debate is not re solved by arguments based on option pricing theory.