The Economic Value of Exploiting Time-Varying Return Moments
53 Pages Posted: 3 Mar 2008 Last revised: 25 Nov 2008
Date Written: November 1, 2008
This paper studies the economic value of exploiting time variation in risk premia and in the volatility of stock returns for a real-time investor in a dynamic setting. I find that ignoring time variation in these return moments leads to economically and statistically significant utility costs. Time-varying risk premia play a more important role than time-varying volatility in forming portfolio weights and in improving portfolio performance for the real-time investor who can rebalance portfolios quarterly. In addition, dynamic policies are more susceptible to parameter uncertainty than myopic policies. This effect further reduces the utility costs of myopic behavior. This study also indicates that conducting an out-of-sample evaluation is necessary to assess the value of a dynamic portfolio policy because in-sample analysis can be misleading.
Keywords: Dynamic portfolio choices, real-time portfolio performance, out-of-sample portfolio performance
JEL Classification: G11
Suggested Citation: Suggested Citation