NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Asset Pricing Models: Implications for Expected Returns and Portfolio Selection

A. Craig MacKinlay, Lubos Pastor

NBER Working Paper No. 7162
Issued in June 1999
NBER Program(s):   AP

Implications of factor-based asset pricing models for estimation of expected returns and for portfolio selection are investigated. In the presence of model mispricing due to a missing risk factor, the mispricing and the residual covariance matrix are linked together. Imposing a strong form of this link leads to expected return estimates that are more precise and more stable over time than unrestricted estimates. Optimal portfolio weights that incorporate the link when no factors are observable are proportional to expected return estimates, effectively using an identity matrix as a covariance matrix. The resulting portfolios perform well both in simulations and in out-of-sample comparisons.

download in pdf format
   (474 K)

email paper

This paper is available as PDF (474 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w7162

Published: MacKinlay, A. Craig and L. Pastor. "Asset Pricing Models: Implications For Expected Returns And Portfolio Selection," Review of Financial Studies, 2000, v13(4,Winter), 883-916.

Users who downloaded this paper also downloaded these:
Pastor and Stambaugh w7284 Comparing Asset Pricing Models: An Investment Perspective
Jagannathan and Ma w8922 Risk Reduction in Large Portfolios: Why Imposing the Wrong Constraints Helps
Chan, Karceski, and Lakonishok w7039 On Portfolio Optimization: Forecasting Covariances and Choosing the Risk Model
Lehmann and Modest w1725 The Empirical Foundations of the Arbitrage Pricing Theory I: The Empirical Tests
Lo and MacKinlay w2960 An Econometric Analysis of Nonsynchronous Trading
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us