Bayesian Inference and Portfolio Efficiency

Abstract:     
A Bayesian approach is used to investigate a sample's information about a portfolio's degree of inefficiency. With standard diffuse priors, posterior distributions for measures of portfolio ineffciency can concentrate well away from values consistent with efficiency, even when the port- folio is exactly efficient in the sample. The data indicate that the NYSE-AMEX market portfolio is rather inefficient in the presence of a riskless asset, although this conclusion is justified only after an analysis using informative priors. Including a riskless asset significantly reduces any sample's ability to produce posterior distributions supporting small degrees of inefficiency.

JEL Classification: G11, G12

Accepted Paper Series