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Bayesian Inference and Portfolio Efficiency

  • Kandel, S.
  • McCulloch, R.
  • Stambaugh, R.F.

A Bayesian approach is used to investigate a sample's information about a portfolio's degree of inefficiency. With standard diffuse priors, posterior distributions for measures of portfolio inefficiency can concentrate well away from values consistent with efficiency, even when the portfolio is exactly efficient in the sample. The data indicate that the NYSE - AMEX market portfolio is rather inefficient in the presence of a riskless asset, although this conclusion is justified only after an analysis using informative priors. Including a riskless asset significantly reduces any sample's ability to produce posterior distributions supporting small degrees of inefficiency. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

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Paper provided by Wharton School - Weiss Center for International Financial Research in its series Weiss Center Working Papers with number 8-91.

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Length: 15 pages
Date of creation: 1991
Date of revision:
Handle: RePEc:fth:pennif:8-91
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  1. Shanken, Jay, 1987. "A Bayesian approach to testing portfolio efficiency," Journal of Financial Economics, Elsevier, vol. 19(2), pages 195-215, December.
  2. Gibbons, Michael R & Ross, Stephen A & Shanken, Jay, 1989. "A Test of the Efficiency of a Given Portfolio," Econometrica, Econometric Society, vol. 57(5), pages 1121-52, September.
  3. Kandel, Shmuel & Stambaugh, Robert F, 1989. "A Mean-Variance Framework for Tests of Asset Pricing Models," Review of Financial Studies, Society for Financial Studies, vol. 2(2), pages 125-56.
  4. Harvey, Campbell R. & Zhou, Guofu, 1990. "Bayesian inference in asset pricing tests," Journal of Financial Economics, Elsevier, vol. 26(2), pages 221-254, August.
  5. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-55, July.
  6. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  7. Geweke, John, 1989. "Bayesian Inference in Econometric Models Using Monte Carlo Integration," Econometrica, Econometric Society, vol. 57(6), pages 1317-39, November.
  8. McCulloch, Robert & Rossi, Peter E., 1990. "Posterior, predictive, and utility-based approaches to testing the arbitrage pricing theory," Journal of Financial Economics, Elsevier, vol. 28(1-2), pages 7-38.
  9. Breeden, Douglas T., 1979. "An intertemporal asset pricing model with stochastic consumption and investment opportunities," Journal of Financial Economics, Elsevier, vol. 7(3), pages 265-296, September.
  10. Ferson, Wayne E & Kandel, Shmuel & Stambaugh, Robert F, 1987. " Tests of Asset Pricing with Time-Varying Expected Risk Premiums and Market Betas," Journal of Finance, American Finance Association, vol. 42(2), pages 201-20, June.
  11. Oldfield, George S. & Rogalski, Richard J., 1987. "The stochastic properties of term structure movements," Journal of Monetary Economics, Elsevier, vol. 19(2), pages 229-254, March.
  12. Kandel, Shmuel & Stambaugh, Robert F., 1987. "On correlations and inferences about mean-variance efficiency," Journal of Financial Economics, Elsevier, vol. 18(1), pages 61-90, March.
  13. McCulloch, Robert & Rossi, Peter E., 1991. "A bayesian approach to testing the arbitrage pricing theory," Journal of Econometrics, Elsevier, vol. 49(1-2), pages 141-168.
  14. Shanken, Jay, 1987. "Multivariate proxies and asset pricing relations : Living with the Roll critique," Journal of Financial Economics, Elsevier, vol. 18(1), pages 91-110, March.
  15. Roll, Richard, 1977. "A critique of the asset pricing theory's tests Part I: On past and potential testability of the theory," Journal of Financial Economics, Elsevier, vol. 4(2), pages 129-176, March.
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