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Bayesian Inference and Portfolio Efficiency

  • Shmuel Kandel
  • Robert McCulloch
  • Robert F. Stambaugh

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.

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File URL: http://www.nber.org/papers/t0134.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Technical Working Papers with number 0134.

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Date of creation: May 1993
Date of revision:
Publication status: published as in Review of Financial Studies August 1995, pp.1-53.
Handle: RePEc:nbr:nberte:0134
Note: AP
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  1. 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.
  2. Black, Fischer, 1972. "Capital Market Equilibrium with Restricted Borrowing," The Journal of Business, University of Chicago Press, vol. 45(3), pages 444-55, July.
  3. 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.
  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. 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.
  6. 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.
  7. 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.
  8. 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.
  9. 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.
  10. 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.
  11. Geweke, John, 1989. "Bayesian Inference in Econometric Models Using Monte Carlo Integration," Econometrica, Econometric Society, vol. 57(6), pages 1317-39, November.
  12. Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
  13. 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.
  14. 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.
  15. Shanken, Jay, 1987. "A Bayesian approach to testing portfolio efficiency," Journal of Financial Economics, Elsevier, vol. 19(2), pages 195-215, December.
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