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Portfolio Allocation for European Markets with Predictability and Parameter Uncertainty

  • Eric JONDEAU

    (University of Lausanne and Swiss Finance Institute)

  • Michael ROCKINGER

    (University of Lausanne, Swiss Finance Institute and CEPR)

We implement a long-horizon static and dynamic portfolio allocation involving a risk-free and a risky asset. This model is calibrated at a quarterly frequency for ten European countries. We also use maximum-likelihood estimates and Bayesian estimates to account for parameter uncertainty. We find that for most European countries the dividend-price ratio and inflation have predictive power. For countries where returns are predictable, we demonstrate out- of-sample economic significance for the long-horizon allocation. Parameter uncertainty plays a second-order role, dominated by strong variation in the dynamic allocation itself induced by large variations in the state variables. The market timing appears economically relevant for many countries.

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Paper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 10-41.

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Length: 50 pages
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Handle: RePEc:chf:rpseri:rp1041
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