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Understanding portfolio efficiency with conditioning information

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  • Peñaranda, Francisco

Abstract

Contrary to the classic framework of passive strategies, if investors exploit return predictability through active strategies then there is a tension between the mean-variance frontiers that drive empirical work and the mean-variance preferences that are used in finance theory. We show that standard preferences choose portfolios on a frontier that has not been studied in the literature, develop new betas and Sharpe ratios to construct portfolio efficiency tests, and highlight some concerns with current empirical work. An empirical application to active strategies on stock portfolios sorted by size and book-to-market confirms the relevance of our theoretical results.

Suggested Citation

  • Peñaranda, Francisco, 2009. "Understanding portfolio efficiency with conditioning information," LSE Research Online Documents on Economics 24415, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:24415
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    File URL: http://eprints.lse.ac.uk/24415/
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    References listed on IDEAS

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    More about this item

    Keywords

    Beta-pricing; Dynamic portfolio strategies; Jensen’s alpha; Mean-variance frontiers; Sharpe ratios;
    All these keywords.

    JEL classification:

    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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