Dynamic Strategies, Asset Pricing Models, and the Out-of-Sample Performance of the Tangency Portfolio

Download or read book Dynamic Strategies, Asset Pricing Models, and the Out-of-Sample Performance of the Tangency Portfolio written by Cesare Robotti and published by . This book was released on 2014 with total page 57 pages. Available in PDF, EPUB and Kindle. Book excerpt: In this paper, I study the behavior of an investor with unit risk aversion who maximizes a utility function defined over the mean and the variance of a portfolio's return. Conditioning information is accessible without cost and an unconditionally riskless asset is available in the market.The proposed approach makes it possible to compare the performance of a benchmark tangency portfolio formed from the set of unrestricted estimates of portfolio weights) to the performance of a restricted tangency portfolio which uses single-index and multi-index asset pricing models to constrain the first moments of asset returns.The main findings of the paper are summarized as follows: i) The estimates of the constant and time-varying tangency portfolio weights are extremely volatile and imprecise. Using an asset pricing model to constrain mean asset returns eliminates extreme short positions in the underlying securities and improves the precision of the estimates of the weights. ii) Partially restricting mean asset returns according to single-index and multi-index asset pricing models improves the out-of-sample performance of the tangency portfolio. iii) Active investmentstrategies (i.e., strategies that incorporate the role played by conditioning information in investment decisions) strongly dominate passive investment strategies in-sample but do not provide any convincing pattern of improved out-of-sample performance.