Least Squares Predictions and Mean-Variance Analysis

Posted: 29 Feb 2008

See all articles by Enrique Sentana

Enrique Sentana

Centro de Estudios Monetarios y Financieros (CEMFI); Financial Markets Group; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: 2005

Abstract

We compare the Sharpe ratios of traders who combine one riskless and one risky asset following (i) buy and hold strategies; (ii) timing strategies with forecasts from simple; or (iii) multiple regressions; and (iv) passive allocations of (i) and (ii) with mean-variance optimizers. We show that (iv) implicitly uses the linear forecasting rule that maximizes the Sharpe ratio of managed portfolios, but the remaining rankings are unclear. We also suggest generalized method of moments (GMM) estimators to make (iv) operational and evaluate their significance with spanning tests. Finally, we characterize the equivalence between (iii) and (iv), and propose moment tests to assess it.

Keywords: delegated portofolio management, financial forecasting, portfolio performance evaluation, Sharpe ratios, spanning tests

Suggested Citation

Sentana, Enrique, Least Squares Predictions and Mean-Variance Analysis ( 2005). Journal of Financial Econometrics, Vol. 3, Issue 1, pp. 56-78, 2005. Available at SSRN: https://ssrn.com/abstract=821737

Enrique Sentana (Contact Author)

Centro de Estudios Monetarios y Financieros (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
Spain
+34 91 429 0551 (Phone)
+34 91 429 1056 (Fax)

HOME PAGE: http://www.cemfi.es/~sentana/

Financial Markets Group

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London School of Economics & Political Science (LSE)
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+44 20 7955 7002 (Phone)
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Centre for Economic Policy Research (CEPR)

London
United Kingdom

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