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Portfolio performance of linear SDF models: an out-of-sample assessment

ISI: Portfolio performance of linear SDF models: an out-of-sample assessment

ERWIN HANSEN S., MASSIMO GUIDOLIN., MARTÍN LOZANO-BANDA.

2018 - Quantitative Finance - Volume 18, 2018 - Issue 8. Pp 1425 - 1436

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.

Keywords

Linear asset pricing models, Stochastic discount factor, Portfolio selection, Out-of-sample performance.

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