Portfolio Inefficiency and the Cross-Section of Expected Returns

26 Pages Posted: 8 Nov 2011  

Shmuel Kandel

affiliation not provided to SSRN

Robert F. Stambaugh

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Date Written: April 1994

Abstract

A plot of expected returns versus betas obeys virtually no relation to an inefficient index portfolio's mean-variance location. If the index portfolio is inefficient, then the coefficients and R- squared from an ordinary-least-squares regression of expected returns on betas can equal essentially any desired values. The mean-variance location of the index does determine the properties of a cross- sectional mean-beta relation fitted by generalized least squares (GLS). As the index portfolio moves closer to exact efficiency, the GLS mean-beta relation moves closer to the exact linear relation corresponding to an efficient portfolio with the same variance. The goodness-of-fit for the GLS regression is the index portfolio's squared relative efficiency, which measures closeness to efficiency in mean-variance space.

Suggested Citation

Kandel, Shmuel and Stambaugh, Robert F., Portfolio Inefficiency and the Cross-Section of Expected Returns (April 1994). NBER Working Paper No. w4702. Available at SSRN: https://ssrn.com/abstract=1956408

Shmuel Kandel (Contact Author)

affiliation not provided to SSRN

Robert F. Stambaugh

University of Pennsylvania - The Wharton School ( email )

The Wharton School, Finance Department
University of Pennsylvania
Philadelphia, PA 19104-6367
United States
215-898-5734 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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