Combination Return Forecasts and Portfolio Allocation with the Cross-Section of Book-to-Market Ratios
Review of Finance, Forthcoming
64 Pages Posted: 1 Jul 2016 Last revised: 21 Sep 2017
Date Written: June 30, 2017
In this paper, we forecast industry returns out-of-sample using the cross-section of book-to-market ratios and investigate whether investors can exploit this predictability in portfolio allocation. Cash-flow and return forecasting regressions show that cross-industry book-to-market ratios contain significant predictive information beyond aggregate and industry-specific book-to-market ratios. Forecast combination methods based on industry book-to-market ratios generate significant out-of-sample predictability for many industries. Real-time portfolio-rotation strategies that buy industries with high predicted returns and short industries with low predicted returns based on combination forecasts earn significant alpha with respect to standard asset pricing models net of transaction costs.
Keywords: Industry Return Predictability, Portfolio Allocation, Book-to-Market
JEL Classification: G11, G12, G17
Suggested Citation: Suggested Citation