Stock Return Serial Dependence and Out-of-Sample Portfolio Performance
London Business School - Department of Management Science and Operations
Francisco J. Nogales
Universidad Carlos III de Madrid - Department of Statistics
EDHEC Business School;
April 22, 2013
AFA 2011 Denver Meetings Paper
We study whether investors can exploit serial dependence in stock returns to improve out-of-sample portfolio performance. We show that a vector-autoregressive (VAR) model captures stock return serial dependence in a statistically significant manner. Analytically, we demonstrate that, unlike contrarian and momentum portfolios, an arbitrage portfolio based on the VAR model attains positive expected returns regardless of the sign of asset return cross-covariances and autocovariances. Empirically, we show, however, that both the arbitrage and mean-variance portfolios based on the VAR model outperform the traditional unconditional portfolios only for transaction costs below ten basis points.
Number of Pages in PDF File: 71
JEL Classification: G11
Date posted: March 17, 2010 ; Last revised: November 14, 2013
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