Are Capital Markets Inefficient on a Macro Level?

Abstract

Samuelson’s dictum (1998) states that capital markets are “macro inefficient”. If this conjecture is true, returns should be partially predictable across different asset classes. We test for the predictability of returns on an asset class level by exploiting the advantageous features of the parametric portfolio policy approach proposed by Brandt, Santa-Clara and Valkanov (2009). We apply the parametric portfolio policy framework in a multi asset investment universe and perform a number of robustness checks such as varying the degree of risk aversion, conducting out-of-sample analyses and including transaction costs. Our results demonstrate that the parametric portfolio policy approach generates positive excess returns after costs in an out-of-sample setting by parameterizing the asset weights as a function of the assets’ value and momentum characteristics. The optimal strategy is a combination of value and momentum investing and depends on the risk aversion of investors. Risk-averse investors benefit from focusing on value investing, while our results advise risk-seeking investors to favor momentum investing. Overall, our analysis indicates that capital markets are inefficient on a macro level.

Keywords: parametric portfolio policy, value investing, momentum

JEL Classification: G12