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Are Vector Autoregressions And Accurate Model For Dynamic Asset Allocation?

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Author Info
Francisco Peñaranda () (CEMFI, Centro de Estudios Monetarios y Financieros)
Abstract

Much of the growing literature on tactical and strategic asset allocation uses vector autoregressive models (VAR) for returns and predictors. Since the portfolio advice they generate may be misleading if those models are not an accurate description of reality, we evaluate the implied joint density forecasts of US monthly excess returns on stocks and bonds. From the point of view of an investor who rebalances monthly, a VAR offers a reasonable description of the data, which is not improved upon by richer models. We also study the relevance of considering time-varying risk premia and parameter uncertainty in density forecasts.

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Paper provided by CEMFI in its series Working Papers with number wp2004_0419.

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Date of creation: Nov 2004
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Handle: RePEc:cmf:wpaper:wp2004_0419

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Related research
Keywords: Density forecasts; parameter uncertainty; portfolio choice; probability integral transform; risk premia.;

Find related papers by JEL classification:
G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
C53 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Forecasting and Other Model Applications

This paper has been announced in the following NEP Reports:

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  3. John Y. Campbell & Yeung Lewis Chan & Luis M. Viceira, 2001. "A Multivariate Model of Strategic Asset Allocation," NBER Working Papers 8566, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  4. Hamilton, James D, 1989. "A New Approach to the Economic Analysis of Nonstationary Time Series and the Business Cycle," Econometrica, Econometric Society, vol. 57(2), pages 357-84, March. [Downloadable!] (restricted)
  5. Ang, Andrew & Chen, Joseph, 2002. "Asymmetric correlations of equity portfolios," Journal of Financial Economics, Elsevier, vol. 63(3), pages 443-494, March. [Downloadable!] (restricted)
  6. Marcelle Chauvet & Simon Potter, 1999. "Nonlinear risk," Staff Reports 61, Federal Reserve Bank of New York. [Downloadable!]
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  7. Andrew Ang & Geert Bekaert, 2002. "International Asset Allocation With Regime Shifts," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(4), pages 1137-1187.
  8. 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)
  9. Francis X. Diebold & Jinyong Hahn & Anthony S. Tay, 1999. "Multivariate Density Forecast Evaluation And Calibration In Financial Risk Management: High-Frequency Returns On Foreign Exchange," The Review of Economics and Statistics, MIT Press, vol. 81(4), pages 661-673, November. [Downloadable!] (restricted)
  10. Clements, M.P. & Smith J., 1998. "Evaluating The Forecast of Densities of Linear and Non-Linear Models: Applications to Output Growth and Unemployment," The Warwick Economics Research Paper Series (TWERPS) 509, University of Warwick, Department of Economics.
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  12. K. J. Martijn Cremers, 2002. "Stock Return Predictability: A Bayesian Model Selection Perspective," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 15(4), pages 1223-1249.
  13. Chib, Siddhartha & Greenberg, Edward, 1996. "Markov Chain Monte Carlo Simulation Methods in Econometrics," Econometric Theory, Cambridge University Press, vol. 12(03), pages 409-431, August. [Downloadable!]
  14. John Y. Campbell, Robert J. Shiller, 1988. "The Dividend-Price Ratio and Expectations of Future Dividends and Discount Factors," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 1(3), pages 195-228. [Downloadable!] (restricted)
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  15. Hamilton, James D. & Susmel, Raul, 1994. "Autoregressive conditional heteroskedasticity and changes in regime," Journal of Econometrics, Elsevier, vol. 64(1-2), pages 307-333. [Downloadable!] (restricted)
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  16. Christoffersen, Peter F, 1998. "Evaluating Interval Forecasts," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(4), pages 841-62, November.
  17. repec:cup:etheor:v:12:y:1996:i:3:p:409-31 is not listed on IDEAS
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