Andrea Buraschi, Andrea Carnelli

Open access

The economic value of predictability in portfolio management

  • Abstract

Informations and abstract

Keywords: Equity Premium; Stock Returns; Dividend Yield; Out-of-Sample Prediction; Portfolio Choice (JEL Codes: G11; G14; G17)

This paper evaluates the evidence on return predictability from an economic perspective: it asks whether investors would have been able and willing to exploit dividend price signals in order to allocate capital efficiently. We use a simple model that incorporates a time varying investment opportunity set into a mean-variance portfolio maximization framework, and derive the optimal capital allocation weights for: (i) a naive strategy based on average realized returns; and (ii) a class of strategies that condition on dividend-price signals. While our data supports in-sample evidence of return predictability, the out-of-sample returns of the naive strategy are higher than those of all conditional portfolio specifications based on a certainty equivalent metric and portfolio turnover. The degree of underperformance is most dramatic in the last three decades: an investor who had used dividend-price ratios as signals for capital allocation in the period 1990-2012 would have consistently generated lower returns than by following a naive strategy. These results suggest that dividend-price predictability offers no economic value to investors.

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