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(Almost) Model‐Free Recovery

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  • PAUL SCHNEIDER
  • FABIO TROJANI

Abstract

Under mild assumptions, we recover the model‐free conditional minimum variance projection of the pricing kernel on various tradeable realized moments of market returns. Recovered conditional moments predict future realizations and give insight into the cyclicality of equity premia, variance risk premia, and the highest attainable Sharpe ratios under the minimum variance probability. The pricing kernel projections are often U‐shaped and give rise to optimal conditional portfolio strategies with plausible market timing properties, moderate countercyclical exposures to higher realized moments, and favorable out‐of‐sample Sharpe ratios.

Suggested Citation

  • Paul Schneider & Fabio Trojani, 2019. "(Almost) Model‐Free Recovery," Journal of Finance, American Finance Association, vol. 74(1), pages 323-370, February.
    • Handle: RePEc:bla:jfinan:v:74:y:2019:i:1:p:323-370
    DOI: 10.1111/jofi.12737
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    Cited by:

    1. Fousseni Chabi-Yo & Chukwuma Dim & Grigory Vilkov, 2023. "Generalized Bounds on the Conditional Expected Excess Return on Individual Stocks," Management Science, INFORMS, vol. 69(2), pages 922-939, February.
    2. Can Gao & Ian W. R. Martin, 2021. "Volatility, Valuation Ratios, and Bubbles: An Empirical Measure of Market Sentiment," Journal of Finance, American Finance Association, vol. 76(6), pages 3211-3254, December.
    3. Eric Renault & Thijs Van Der & Bas J M Werker, 2023. "Arbitrage Pricing Theory for Idiosyncratic Variance Factors," Journal of Financial Econometrics, Oxford University Press, vol. 21(5), pages 1403-1442.
    4. Paolo Guasoni & Eberhard Mayerhofer, 2020. "Technical Note—Options Portfolio Selection," Operations Research, INFORMS, vol. 68(3), pages 733-740, May.
    5. Wang, Yunqi & Zhou, Ti, 2023. "Out-of-sample equity premium prediction: The role of option-implied constraints," Journal of Empirical Finance, Elsevier, vol. 70(C), pages 199-226.
    6. Ian Martin, 2021. "On the Autocorrelation of the Stock Market [X-CAPM: An Extrapolative Capital Asset Pricing Model]," Journal of Financial Econometrics, Oxford University Press, vol. 19(1), pages 39-52.
    7. Chabi-Yo, Fousseni & Loudis, Johnathan, 2020. "The conditional expected market return," Journal of Financial Economics, Elsevier, vol. 137(3), pages 752-786.

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