Frequency-Domain Information for Active Portfolio Management

Abstract

We assess the benefits of using frequency-domain information for active portfolio management. To do so, we forecast the bond risk premium and equity risk premium using a methodology that isolates frequencies (of the predictors) with the highest predictive power. The resulting forecasts are more accurate than those of traditional forecasting methods for both asset classes. When used in the context of active portfolio management, the forecasts based on frequency-domain information lead to better portfolio performances than when using the original time series of the predictors. It produces higher information ratio (0.57 vs 0.45), higher CER gains (1.12% vs 0.81%), and lower maximum drawdown (19.1% vs 19.6%).

Keywords: equity risk premium, bond risk premium, predictability, multiresolution analysis, active portfolio management

JEL Classification: C58, G11, G17