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Implied returns and the choice of a mean-variance efficient portfolio proxy
Project responsable David Ardia
   
Project partner Kris Boudt
   
Abstract Implied expected returns are the expected returns for which a supposedly mean-variance efficient portfolio is effectively efficient given a covariance matrix. We analyze the statistical properties of monthly implied expected return estimates and study their sensitivity to the choice of a mean-variance efficient portfolio proxy. Over the period January 1984 to December 2012 and for the universe of S&P 100 stocks we find that the largest gains are in terms of stability of the return forecasts. The use of a maximum diversification or equal-risk-contribution portfolio as proxy reduces significantly the cross-section and time series dispersion in the implied expected return forecasts and leads to a small improvement in forecast precision, compared to using a market capitalization, fundamental value or equal weighting scheme. For all proxies considered, the implied expected return estimates outperform the time series model based forecasts in terms of stability and forecast precision.
   
Keywords Implied expected return, mean-variance, portfolio allocation, reverse engineering, risk-based allocation
   
Project homepage http://dx.doi.org/10.2139/ssrn.2215042
   
Type of project Applied research project
Research area Finance
Status Completed
Start of project 1-2013
End of project 12-2015
Overall budget 30,000 CAD
Additional info Subvention, Université Laval - démarrage nouveau chercheur
Contact David Ardia