No abstract

No abstract

No abstract

No abstract

In this paper, we analytically derive the expected loss function associated with using sample means and the covariance matrix of returns to estimate the optimal portfolio. Our analytical results show that the standard plug-in approach that replaces the population parameters by their sample estimates can lead to very poor out-of-sample performance. We further show that with parameter uncertainty, holding the sample tangency portfolio and the riskless asset is never optimal. An investor can benefit by holding some other risky portfolios that help reduce the estimation risk. In particular, we show that a portfolio that optimally combines the riskless asset, the sample tangency portfolio, and the sample global minimum-variance portfolio dominates a portfolio with just the riskless asset and the sample tangency portfolio, suggesting that the presence of estimation risk completely alters the theoretical recommendation of a two-fund portfolio.

We present significant evidence of out-of-sample equity premium predictability for a host of industrialized countries over the postwar period. There are important differences, however, in the nature of equity premium predictability between the United States and other developed countries. Taken collectively, U.S. economic variables are significant out-of-sample predictors of the U.S. equity premium that clearly outperform lagged international stock returns. In contrast, lagged international stock returns-especially lagged U.S. returns-substantially outperform economic variables as out-of-sample equity premium predictors for non-U.S. countries, pointing to a leading role for the United States with respect to international return predictability. These predictability patterns are enhanced during economic downturns, linking return predictability to business-cycle fluctuations and information frictions involving the diffusion of news on macroeconomic fundamentals across countries. The leading role of the United States stands out during the recent global financial crisis: lagged U.S. stock returns deliver especially sizable gains for forecasting the monthly equity premium in other countries, evidenced by out-of-sample R 2 statistics of 10% or greater, more than triple the postwar average.JEL classifications: C22, C53, G14, G15, G17

No abstract

No abstract