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Asset Pricing Models: Implications for Expected Returns and Portfolio Selection

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  • A. CRAIG MacKINLAY
  • LUBOŠ PÁSTOR

Abstract

Implications of factor-based asset pricing models for estimation of expected returns and for portfolio selection are investigated. In the presence of model mispricing due to a missing risk factor, the mispricing and the residual covariance matrix are linked together. Imposing a strong form of this link leads to expected return estimates that are more precise and more stable over time than unrestricted estimates. Optimal portfolio weights that incorporate the link when no factors are observable are proportional to expected return estimates, effectively using an identity matrix as a covariance matrix. The resulting portfolios perform well both in simulations and in out-of-sample comparisons.
(This abstract was borrowed from another version of this item.)
(This abstract was borrowed from another version of this item.)

Suggested Citation

  • A. CRAIG MacKINLAY & LUBOŠ PÁSTOR, "undated". "Asset Pricing Models: Implications for Expected Returns and Portfolio Selection," CRSP working papers 510, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    • Handle: RePEc:wop:chispw:510
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    JEL classification:

    • G1 - Financial Economics - - General Financial Markets

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