Portfolio Allocation for European Markets with Predictability and Parameter Uncertainty
University of Lausanne; Swiss Finance Institute
University of Lausanne - School of Economics and Business Administration (HEC-Lausanne); Centre for Economic Policy Research (CEPR); Swiss Finance Institute
August 1, 2010
Swiss Finance Institute Research Paper No. 10-41
We implement a long-horizon static and dynamic portfolio allocation involving a risk-free and a risky asset. This model is calibrated at a quarterly frequency for ten European countries. We also use maximum-likelihood estimates and Bayesian estimates to account for parameter uncertainty. We find that for most European countries the dividend-price ratio and inflation have predictive power. For countries where returns are predictable, we demonstrate out-of-sample economic signicance for the long-horizon allocation. Parameter uncertainty plays a second-order role, dominated by strong variation in the dynamic allocation itself induced by large variations in the state variables. The market timing appears economically relevant for many countries.
Number of Pages in PDF File: 50
Keywords: Stock Returns, Predictability, Estimation risk, Portfolio Choice
JEL Classification: C11, C22, C32, C51, C61, G11
Date posted: September 28, 2010
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