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Sequential Optimal Portfolio Performance: Market and Volatility Timing

48 Pages Posted: 24 Mar 2002  

Michael S. Johannes

Columbia Business School - Finance and Economics

Nick Polson

University of Chicago - Booth School of Business

Jonathan R Stroud

McDonough School of Business, Georgetown University

Date Written: February 2002

Abstract

This paper studies the economic benefits of return predictability by analyzing the impact of market and volatility timing on the performance of optimal portfolio rules. Using a model with time-varying expected returns and volatility, we form optimal portfolios sequentially and generate out-of-sample portfolio returns. We are careful to account for estimation risk and parameter learning. Using S&P 500 index data from 1980-2000, we find that a strategy based solely on volatility timing uniformly outperforms market timing strategies, a model that assumes no predictability and the market return in terms of certainty equivalent gains and Sharpe ratios. Market timing strategies perform poorly due estimation risk, which is the substantial uncertainty present in estimating and forecasting expected returns.

JEL Classification: C12, C22, G11

Suggested Citation

Johannes, Michael S. and Polson, Nick and Stroud, Jonathan R, Sequential Optimal Portfolio Performance: Market and Volatility Timing (February 2002). Available at SSRN: https://ssrn.com/abstract=304976 or http://dx.doi.org/10.2139/ssrn.304976

Michael Slater Johannes (Contact Author)

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

Nick Polson

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
773-702-7513 (Phone)
773-702-0458 (Fax)

Jonathan R. Stroud

McDonough School of Business, Georgetown University ( email )

3700 O Street NW
Washington, DC 20057
United States

HOME PAGE: http://jonathanrstroud.com

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