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Least Squares Predictions and Mean-Variance Analysis

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  • Sentana, Enrique

Abstract

We compare the Sharpe ratios of investment funds which combine one riskless and one risky asset following: i) timing strategies which forecast excess returns using simple regressions; ii) a strategy which uses multiple regression instead; and iii) a passive allocation which combines the funds in i) with constant weightings. We show that iii) dominates i) and ii), as it implicitly uses the linear forecasting rule that maximises the Sharpe ratio of actively traded portfolios, but the relative ranking of i) and ii) is generally unclear. We also discuss under what circumstances the performance of ii) and iii) coincides.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 2088.

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Date of creation: Feb 1999
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Handle: RePEc:cpr:ceprdp:2088

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Related research

Keywords: Forecasting; Market timing strategies; Portfolio Allocation; Sharpe Ratios;

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References

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  1. Hansen, Lars Peter & Richard, Scott F, 1987. "The Role of Conditioning Information in Deducing Testable," Econometrica, Econometric Society, vol. 55(3), pages 587-613, May.
  2. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  3. Chen, Zhiwu & Knez, Peter J, 1996. "Portfolio Performance Measurement: Theory and Applications," Review of Financial Studies, Society for Financial Studies, vol. 9(2), pages 511-55.
  4. Arellano, Manuel, 1989. "On the efficient estimation of simultaneous equations with covariance restrictions," Journal of Econometrics, Elsevier, vol. 42(2), pages 247-265, October.
  5. Admati, Anat R & Pfleiderer, Paul, 1990. "Direct and Indirect Sale of Information," Econometrica, Econometric Society, vol. 58(4), pages 901-28, July.
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Cited by:
  1. Patton, Andrew J. & Timmermann, Allan, 2007. "Properties of optimal forecasts under asymmetric loss and nonlinearity," Journal of Econometrics, Elsevier, vol. 140(2), pages 884-918, October.
  2. Francisco Peñaranda & Enrique Sentana, 2004. "Spanning Tests In Return And Stochastic Discount Factor Mean-Variance Frontiers: A Unifying Approach," Working Papers wp2004_0410, CEMFI.
  3. Enrique Sentana, 2008. "The Econometrics Of Mean-Variance Efficiency Tests: A Survey," Working Papers wp2008_0807, CEMFI.
  4. Allan Timmermann & Andrew J. Patton, 2004. "Properties of Optimal Forecasts," Econometric Society 2004 North American Winter Meetings 234, Econometric Society.

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