TY  - JOUR
AU  - Wachter,Jessica A.
AU  - Warusawitharana,Missaka
TI  - Predictable Returns and Asset Allocation: Should a Skeptical Investor Time the Market?
JF  - National Bureau of Economic Research Working Paper Series
VL  - No. 13165
PY  - 2007
Y2  - June 2007
UR  - http://www.nber.org/papers/w13165
L1  - http://www.nber.org/papers/w13165.pdf
N1  - Author contact info:
Jessica Wachter
Department of Finance
2300 SH-DH
The Wharton School
University of Pennsylvania
3620 Locust Walk
Philadelphia, PA 19104
Tel: 215/898-7634
Fax: 215/898-6200
E-Mail: jwachter@wharton.upenn.edu

Missaka Warusawitharana
Department of Research and Statistics
Board of Governors of the Federal Reserve
Mail Stop 97
20th and Constitution Ave
Washington D.C., 20551
E-Mail: Missaka.N.Warusawitharana@frb.gov
AB  - Are excess returns predictable and if so, what does this mean for investors?  Previous literature has tended toward two polar viewpoints: that predictability is useful only if the statistical evidence for it is incontrovertible, or that predictability should affect portfolio choice, even if the evidence is weak according to conventional measures.  This paper models an intermediate view: that both data and theory are useful for decision-making.  We investigate optimal portfolio choice for an investor who is skeptical about the amount of predictability in the data.  Skepticism is modeled as an informative prior over the R^2 of the predictive regression.  We find that the evidence is sufficient to convince even an investor with a highly skeptical prior to vary his portfolio on the basis of the dividend-price ratio and the yield spread.  The resulting weights are less volatile and deliver superior out-of-sample performance as compared to the weights implied by an entirely model-based or data-based view. 
ER  -