Asset Allocation with Business Cycle Dependent Return Predictability

61 Pages Posted: 22 Feb 2015

Date Written: September 1, 2014


I compute economic gains for a power utility investor from taking business cycle dependent return predictability into account. Recent studies show that stock returns are only predictable in recessions, and bond returns are only predictable in expansions. I examine whether this finding can be exploited in real-time trading using modern forecasting models combined with business cycle dummies. Realized utilities are computed both for a one-period and a long-horizon investor. Given total certainty about the timing and duration of recessions, I find that there are significant economic gains to be made using these dummy switching models rather than their no switch versions. However, the gains largely disappear for even modest inaccuracy of techniques that identify business cycle turning points in real-time.

Keywords: Portfolio choice, business cycles, return predictability, bootstrap

JEL Classification: C53, G11

Suggested Citation

Sander, Magnus, Asset Allocation with Business Cycle Dependent Return Predictability (September 1, 2014). Available at SSRN: or

Magnus Sander (Contact Author)

Aarhus University - CREATES ( email )

Nordre Ringgade 1
DK-8000 Aarhus C, 8000

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