Portfolio Efficiency and Discount Factor Bounds with Conditioning Information: An Empirical Study

Abstract

In this paper, we study the properties of unconditionally efficient portfolios and discount factor bounds in the presence of conditioning information. The main contribution of this paper is to provide a detailed comparison between various stochastic discount factor bounds with conditioning information. We do this by exploiting the explicit link between the stochastic discount factor approach and portfolio efficiency in the presence of conditioning information. For common choices of base assets and conditioning instruments, we find that the "unconditionally efficient" bounds of Ferson and Siegel (2002) are statistically indistinguishable from the (theoretically) optimal bounds of Gallant, Hansen, and Tauchen (1990), while having smaller sampling variability. We demonstrate that the difference in sampling variability of the UE and GHT bounds is due to the different behavior of the portfolio weights underlying their construction. Our work is closely related to and extends Ferson and Siegel (2001), Ferson and Siegel (2002) and Bekaert and Liu (2001).