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

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  • Li, GuangJie

    ()
    (Cardiff Business School)

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

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  1. Pesaran, M Hashem & Timmermann, Allan, 1995. " Predictability of Stock Returns: Robustness and Economic Significance," Journal of Finance, American Finance Association, vol. 50(4), pages 1201-28, September.
  2. 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.
  3. Carmen Fernandez & E Ley & Mark F J Steel, 2004. "Benchmark priors for Bayesian models averaging," ESE Discussion Papers 66, Edinburgh School of Economics, University of Edinburgh.
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. Granger, Clive W. J., 1992. "Forecasting stock market prices: Lessons for forecasters," International Journal of Forecasting, Elsevier, vol. 8(1), pages 3-13, June.
  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.
  10. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Society for Financial Studies, vol. 5(3), pages 357-86.
  11. 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.
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