Working Paper: CEPR ID: DP2088
Authors: Enrique Sentana
Abstract: We compare the Sharpe ratios of investment funds which combine one riskless and one risky asset following: i) timing strategies which forecast excess returns using simple regressions; ii) a strategy which uses multiple regression instead; and iii) a passive allocation which combines the funds in i) with constant weightings. We show that iii) dominates i) and ii), as it implicitly uses the linear forecasting rule that maximises the Sharpe ratio of actively traded portfolios, but the relative ranking of i) and ii) is generally unclear. We also discuss under what circumstances the performance of ii) and iii) coincides.
Keywords: Sharpe ratios; portfolio allocation; market timing strategies; forecasting
JEL Codes: G11
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Passive Portfolio Allocation (iii) (G11) | Sharpe Ratio (G11) |
| Dynamic Portfolio Allocations (i) (G11) | Sharpe Ratio (G11) |
| Active Strategy (ii) (L29) | Sharpe Ratio (G11) |
| Sharpe Ratio of Optimal Portfolio (G11) | Sharpe Ratios of Underlying Funds (G23) |
| Sharpe Ratio of Optimal Portfolio (G11) | Correlation Matrix of Underlying Funds (C10) |
| Manager using all information (ii) (D89) | Manager using specific signal (i) (C69) |