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Long horizon predictability: An asset allocation perspective

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  • Lioui, Abraham
  • Poncet, Patrice

Abstract

Consider investors with a 10-year investment horizon who rebalance their portfolio at the monthly frequency. Should they use information from monthly returns, 10-year returns or intermediate returns to build their optimal portfolios? When stock and bond returns are i.i.d., the frequency of returns is not relevant. However, when they are predictable, it is. Using a new estimation approach and before correcting for overlapping observations, we show that the positive impact of predictability on investors’ welfare is stronger for longer prediction horizons and the more so as the investment horizon enlarges. This welfare improvement is achieved by adopting realistic portfolio positions. When we correct for the persistence in the predictive regression residuals due to overlapping observations, our results are preserved for short to medium investment horizons although the added value of long horizon predictability is reduced. Our results are robust to various checks and also hold out-of-sample. Overall, short to medium term investors should exploit long horizon predictability even though they rebalance their portfolios at high frequency.

Suggested Citation

  • Lioui, Abraham & Poncet, Patrice, 2019. "Long horizon predictability: An asset allocation perspective," European Journal of Operational Research, Elsevier, vol. 278(3), pages 961-975.
    • Handle: RePEc:eee:ejores:v:278:y:2019:i:3:p:961-975
    DOI: 10.1016/j.ejor.2019.04.040
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    Cited by:

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    2. Ioannis Kyriakou & Parastoo Mousavi & Jens Perch Nielsen & Michael Scholz, 2020. "Longer-Term Forecasting of Excess Stock Returns—The Five-Year Case," Mathematics, MDPI, vol. 8(6), pages 1-20, June.
    3. Ioannis Kyriakou & Parastoo Mousavi & Jens Perch Nielsen & Michael Scholz, 2020. "Short-Term Exuberance and long-term stability: A simultaneous optimization of stock return predictions for short and long horizons," Graz Economics Papers 2020-20, University of Graz, Department of Economics.

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