The Performance of Characteristic-Sorted Portfolios: Evaluating the Past and Predicting the Future

50 Pages Posted: 23 Nov 2021

See all articles by Aydogan Alti

Aydogan Alti

University of Texas at Austin - Department of Finance

Travis L. Johnson

The University of Texas at Austin

Sheridan Titman

University of Texas at Austin - Department of Finance; National Bureau of Economic Research (NBER)

Date Written: November 18, 2021

Abstract

The expected returns of most portfolios are likely to fluctuate over time. We present a statistical model that allows for such fluctuations and apply the model to analyze the returns of characteristic-sorted portfolios, such as value minus growth. We find that accounting for plausible magnitudes of persistent variation in returns doubles the standard errors of these portfolios' expected return estimates. We also analyze characteristic-sorted portfolios from the perspective of Bayesian investors and show that investors' posterior beliefs about expected returns are highly dependent on their priors about persistence.

Keywords: Portfolio returns, time-variation, autocorrelation, value strategies, return predictability, Bayesian

JEL Classification: G10, G11, G12, G14

Suggested Citation

Alti, Aydogan and Johnson, Travis L. and Titman, Sheridan, The Performance of Characteristic-Sorted Portfolios: Evaluating the Past and Predicting the Future (November 18, 2021). Available at SSRN: https://ssrn.com/abstract=3966667 or http://dx.doi.org/10.2139/ssrn.3966667

Aydogan Alti

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

Travis L. Johnson (Contact Author)

The University of Texas at Austin ( email )

2110 Speedway Stop B6600
Austin, TX Texas 78712
United States
6178995325 (Phone)

HOME PAGE: http://travislakejohnson.com

Sheridan Titman

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States
512-232-2787 (Phone)
512-471-5073 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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