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Mean-variance theory with imprecise accounting information

Author

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  • Jacoby, Gady
  • Li, Shi
  • Wang, Yan

Abstract

In this paper, we examine the impact of imprecise accounting information on optimal portfolio choice in the mean-variance sense. We provide a theoretical platform illustrating the exact way in which imprecise return errors affect portfolio choice and alter the optimal vector of weights. We demonstrate that the covariance between actual return and return error could partly offset the impact of low-quality information on variance-covariance matrix. This is in agreement with empirical evidence suggesting that optimal portfolio weights are highly sensitive to small estimation errors in expected returns, but they are less sensitive with respect to errors in return variance estimates.

Suggested Citation

  • Jacoby, Gady & Li, Shi & Wang, Yan, 2018. "Mean-variance theory with imprecise accounting information," Finance Research Letters, Elsevier, vol. 26(C), pages 156-161.
  • Handle: RePEc:eee:finlet:v:26:y:2018:i:c:p:156-161
    DOI: 10.1016/j.frl.2017.12.018
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    References listed on IDEAS

    as
    1. Francis, Jennifer & LaFond, Ryan & Olsson, Per & Schipper, Katherine, 2005. "The market pricing of accruals quality," Journal of Accounting and Economics, Elsevier, vol. 39(2), pages 295-327, June.
    2. Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-887, September.
    3. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, March.
    4. Best, Michael J & Grauer, Robert R, 1991. "On the Sensitivity of Mean-Variance-Efficient Portfolios to Changes in Asset Means: Some Analytical and Computational Results," Review of Financial Studies, Society for Financial Studies, vol. 4(2), pages 315-342.
    5. William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, September.
    6. Richard Lambert & Christian Leuz & Robert E. Verrecchia, 2007. "Accounting Information, Disclosure, and the Cost of Capital," Journal of Accounting Research, Wiley Blackwell, vol. 45(2), pages 385-420, May.
    7. Core, John E. & Guay, Wayne R. & Verdi, Rodrigo, 2008. "Is accruals quality a priced risk factor?," Journal of Accounting and Economics, Elsevier, vol. 46(1), pages 2-22, September.
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    More about this item

    Keywords

    Mean-variance theory; Information quality; Accrual quality; Imprecise information;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions

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