Predictable Returns and Asset Allocation: Should a Skeptical Investor Time the Market? / Jessica A. Wachter, Missaka Warusawitharana.

Format:

Book

Author/Creator:

Wachter, Jessica A.

Contributor:

National Bureau of Economic Research.

Warusawitharana, Missaka.

Series:

Working Paper Series (National Bureau of Economic Research) no. w13165.

NBER working paper series no. w13165

Language:

English

Physical Description:

1 online resource: illustrations (black and white);

Other Title:

Predictable Returns and Asset Allocation

Place of Publication:

Cambridge, Mass. National Bureau of Economic Research 2007.

Summary:

Are excess returns predictable and if so, what does this mean for investors? Previous literature has tended toward two polar viewpoints: that predictability is useful only if the statistical evidence for it is incontrovertible, or that predictability should affect portfolio choice, even if the evidence is weak according to conventional measures. This paper models an intermediate view: that both data and theory are useful for decision-making. We investigate optimal portfolio choice for an investor who is skeptical about the amount of predictability in the data. Skepticism is modeled as an informative prior over the R^2 of the predictive regression. We find that the evidence is sufficient to convince even an investor with a highly skeptical prior to vary his portfolio on the basis of the dividend-price ratio and the yield spread. The resulting weights are less volatile and deliver superior out-of-sample performance as compared to the weights implied by an entirely model-based or data-based view.

Notes:

Print version record

June 2007.