79 Pages Posted: 5 Apr 2017 Last revised: 31 Dec 2019
There are 3 versions of this paper
Predicting Relative Returns
Date Written: December 22, 2019
The optimal factor timing portfolio is equivalent to the stochastic discount factor. We propose and implement a method to characterize both empirically. Our approach imposes restrictions on the dynamics of expected returns which lead to an economically plausible SDF. Market-neutral equity factors are strongly and robustly predictable. Exploiting this predictability leads to substantial improvement in portfolio performance relative to static factor investing. The variance of the corresponding SDF is larger, more variable over time, and exhibits different cyclical behavior than estimates ignoring this fact. These results pose new challenges for theories that aim to match the cross-section of stock returns.
Keywords: Predictability, Returns, Cross Section, Time Series, Equities, Bonds, Foreign Exchange
JEL Classification: G12, G14
Suggested Citation: Suggested Citation