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Constant Mix Portfolios and Risk Aversion

Merton (1969) established the conditions under which a constant mix portfolio strategy is optimal across a multi-period investment horizon. A central tenant of Merton’s paper is that the investor’s portfolio must be rebalanced continuously. In practice, portfolios are not rebalanced continuously, especially by individual investors. As portfolios are rebalanced less frequently the asset mix will drift from the target weights of the constant mix strategy and lower investor utility. We measure this 'drift' indirectly by measuring the difference between the investor’s level of risk aversion and the risk aversion that would make the non-rebalanced portfolio an optimal choice.