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Least Squares Predictions and Mean-Variance Analysis

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  • Enrique Sentana

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  • Enrique Sentana

Abstract

We compare the Sharpe rations 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 maximizes 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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File URL: http://www2.lse.ac.uk/fmg/workingPapers/discussionPapers/fmg_pdfs/dp312.pdf
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Bibliographic Info

Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp312.

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Date of creation: Jan 1999
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Handle: RePEc:fmg:fmgdps:dp312

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Web page: http://www2.lse.ac.uk/fmg/

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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. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
  3. Arellano, Manuel, 1989. "On the efficient estimation of simultaneous equations with covariance restrictions," Journal of Econometrics, Elsevier, vol. 42(2), pages 247-265, October.
  4. 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.
  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 G, 2003. "Properties of Optimal Forecasts," CEPR Discussion Papers 4037, C.E.P.R. Discussion Papers.
  2. Enrique Sentana & Francisco Penaranda, 2004. "Spanning Tests in Return and Stochastic Discount Factor Mean-Variance Frontiers: A Unifying Approach," FMG Discussion Papers dp497, Financial Markets Group.
  3. 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.
  4. Enrique Sentana, 2008. "The Econometrics Of Mean-Variance Efficiency Tests: A Survey," Working Papers wp2008_0807, CEMFI.

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