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Predictable returns and asset allocation: Should a skeptical investor time the market?

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Author Info
Wachter, Jessica A.
Warusawitharana, Missaka

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Abstract

We investigate optimal portfolio choice for an investor who is skeptical about the degree to which excess returns are predictable. Skepticism is modeled as an informative prior over the R2 of the predictive regression. We find that the evidence is sufficient to convince even an investor with a highly skeptical prior to vary his portfolio on the basis of the dividend-price ratio and the yield spread. The resulting weights are less volatile and deliver superior out-of-sample performance as compared to the weights implied by an entirely model-based or data-based view.

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Publisher Info
Article provided by Elsevier in its journal Journal of Econometrics.

Volume (Year): 148 (2009)
Issue (Month): 2 (February)
Pages: 162-178
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Handle: RePEc:eee:econom:v:148:y:2009:i:2:p:162-178

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Web page: http://www.elsevier.com/locate/jeconom

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  1. Jurek, Jakub W & Viceira, Luis M, 2006. "Optimal Value and Growth Tilts in Long-Horizon Portfolios," CEPR Discussion Papers 5773, C.E.P.R. Discussion Papers. [Downloadable!] (restricted)
    Other versions:
  2. Didier, Tatiana & Lowenkron, Alexandre, 2009. "The current account as a dynamic portfolio choice problem," Policy Research Working Paper Series 4861, The World Bank. [Downloadable!]
  3. Lubos Pastor & Robert F. Stambaugh, 2007. "Predictive Systems: Living with Imperfect Predictors," NBER Working Papers 12814, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Gianni Amisano & Roberto Savona, 2008. "Imperfect predictability and mutual fund dynamics. How managers use predictors in changing systematic risk," Working Paper Series 881, European Central Bank. [Downloadable!]
    Other versions:
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This page was last updated on 2009-12-9.

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