Portfolio performance of linear SDF models: an out-of-sample assessment. Issue 8 (3rd August 2018)

• Record Type: Journal Article
• Authors: Guidolin, Massimo; Hansen, Erwin; Lozano-Banda, Martín
• Is Part Of: Quantitative finance. Volume 18:Issue 8(2018)
• Page Start: 1425
• Page End: 1436
• Publication Date: 2018-08-03
• Subjects: Linear asset pricing models -- Stochastic discount factor -- Portfolio selection -- Out-of-sample performance; G11 -- G12; Finance -- Periodicals; Business mathematics -- Periodicals; Finance -- Mathematical models -- Periodicals; Investments -- Mathematics -- Periodicals; Economics -- Periodicals; Finances -- Modèles mathématiques -- Périodiques; 332.015118
• DOI: 10.1080/14697688.2018.1429646
• Languages: English
• ISSNs: 1469-7688

Abstract

Abstract : We evaluate linear stochastic discount factor models using an ex-post portfolio metric: the realized out-of-sample Sharpe ratio of mean–variance portfolios backed by alternative linear factor models. Using a sample of monthly US portfolio returns spanning the period 1968–2016, we find evidence that multifactor linear models have better empirical properties than the CAPM, not only when the cross-section of expected returns is evaluated in-sample, but also when they are used to inform one-month ahead portfolio selection. When we compare portfolios associated to multifactor models with mean–variance decisions implied by the single-factor CAPM, we document statistically significant differences in Sharpe ratios of up to 10 percent. Linear multifactor models that provide the best in-sample fit also yield the highest realized Sharpe ratios.