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The Horizon Effect of Stock Return Predictability and Model Uncertainty on Portfolio Choice: UK Evidence

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Author Info
Li, GuangJie () (Cardiff Business School)

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Abstract

We study how stock return's predictability and model uncertainty affect a rational buy-and-hold investor.s decision to allocate her wealth for different lengths of investment horizons in the UK market. We consider the FTSE All-Share Index as the risky asset, and the UK Treasury bill as the risk free asset in forming the investor's portfolio. We identify the most powerful predictors of the stock return by accounting for model uncertainty. We find that though stock return predictability is weak, it can still affect the investor's optimal portfolio decision over different investment horizons.

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Publisher Info
Paper provided by Cardiff University, Cardiff Business School, Economics Section in its series Cardiff Economics Working Papers with number E2009/4.

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Length: 44 pages
Date of creation: Mar 2009
Date of revision: Aug 2009
Handle: RePEc:cdf:wpaper:2009/4

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Related research
Keywords: stock return predictability; portfolio choice; Bayesian Model Averaging; SUR model;

Find related papers by JEL classification:
C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: General - - - Bayesian Analysis
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets

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  1. Goetzmann, William Nelson & Jorion, Philippe, 1993. " Testing the Predictive Power of Dividend Yields," Journal of Finance, American Finance Association, vol. 48(2), pages 663-79, June. [Downloadable!] (restricted)
    Other versions:
  2. M. Hashem Pesaran & Allan Timmermann, 1995. "Predictability of Stock Returns: Robustness and Economic Significance," University of California at San Diego, Economics Working Paper Series 95-19, Department of Economics, UC San Diego.
    Other versions:
  3. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May. [Downloadable!] (restricted)
  4. Kothari, S. P. & Shanken, Jay, 1997. "Book-to-market, dividend yield, and expected market returns: A time-series analysis," Journal of Financial Economics, Elsevier, vol. 44(2), pages 169-203, May. [Downloadable!] (restricted)
  5. Nicholas Barberis, 2000. "Investing for the Long Run when Returns Are Predictable," Journal of Finance, American Finance Association, vol. 55(1), pages 225-264, 02. [Downloadable!] (restricted)
  6. Fernandez, Carmen & Ley, Eduardo & Steel, Mark F. J., 2001. "Benchmark priors for Bayesian model averaging," Journal of Econometrics, Elsevier, vol. 100(2), pages 381-427, February. [Downloadable!] (restricted)
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  7. Granger, Clive W. J., 1992. "Forecasting stock market prices: Lessons for forecasters," International Journal of Forecasting, Elsevier, vol. 8(1), pages 3-13, June. [Downloadable!] (restricted)
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  8. Samuelson, Paul A, 1969. "Lifetime Portfolio Selection by Dynamic Stochastic Programming," The Review of Economics and Statistics, MIT Press, vol. 51(3), pages 239-46, August. [Downloadable!] (restricted)
  9. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October. [Downloadable!] (restricted)
  10. Banz, Rolf W., 1981. "The relationship between return and market value of common stocks," Journal of Financial Economics, Elsevier, vol. 9(1), pages 3-18, March. [Downloadable!] (restricted)
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