Portfolio Allocation for European Markets with Predictability and Parameter Uncertainty
AbstractWe implement a long-horizon static and dynamic portfolio allocation involving a risk-free and a risky asset. This model is calibrated at a quarterly frequency for ten European countries. We also use maximum-likelihood estimates and Bayesian estimates to account for parameter uncertainty. We find that for most European countries the dividend-price ratio and inflation have predictive power. For countries where returns are predictable, we demonstrate out- of-sample economic significance for the long-horizon allocation. Parameter uncertainty plays a second-order role, dominated by strong variation in the dynamic allocation itself induced by large variations in the state variables. The market timing appears economically relevant for many countries.
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Bibliographic InfoPaper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 10-41.
Length: 50 pages
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Stock returns; Predictability; Estimation risk; Portfolio choice;
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