Portfolio Optimization with Industry Return Prediction Models

52 Pages Posted: 1 Aug 2017

See all articles by Wolfgang Bessler

Wolfgang Bessler

University of Hamburg

Dominik Wolff

Deka Investment GmbH; Darmstadt University of Technology; Frankfurt University of Applied Sciences

Date Written: June 30, 2017

Abstract

We postulate that utilizing return prediction models with fundamental, macroeconomic, and technical indicators instead of using historical averages should result in superior asset allocation decisions. We investigate the predictive power of individual variables for forecasting industry returns in-sample and out-of-sample and then analyze multivariate predictive regression models including OLS, a regularization technique, principal components, a target-relevant latent factor approach, and forecast combinations. The gains from using industry return predictions are evaluated in an out-of-sample Black-Litterman portfolio optimization framework. We provide empirical evidence that portfolio optimization utilizing industry return prediction models significantly outperform portfolios using historical averages and those being passively managed.

Keywords: Portfolio Optimization, Return Forecasts, Predictive Regression, Three-Pass Regression Filter, Black-Litterman Model

JEL Classification: G17, G11, C53

Suggested Citation

Bessler, Wolfgang and Wolff, Dominik and Wolff, Dominik, Portfolio Optimization with Industry Return Prediction Models (June 30, 2017). 30th Australasian Finance and Banking Conference 2017, Available at SSRN: https://ssrn.com/abstract=3011135 or http://dx.doi.org/10.2139/ssrn.3011135

Wolfgang Bessler (Contact Author)

University of Hamburg ( email )

Allende-Platz 1
Hamburg, 20146
Germany

Dominik Wolff

Deka Investment GmbH ( email )

Mainzer Landstrasse 16
Frankfurt am Main, 60325
Germany

Darmstadt University of Technology

Hochschulstraße 1
S1|02 40
Darmstadt, Hessen D-64289
Germany

Frankfurt University of Applied Sciences ( email )

Nibelungenplatz 1
Frankfurt / Main, 60318
Germany

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