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Portfolio Performance of Linear SDF Models: An Out-of-Sample Assessment

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  • Massimo Guidolin
  • Erwin Hansen
  • Martín Lozano-Banda

Abstract

We evaluate linear stochastic discount factor models using an ex-post portfolio metric: the realized out-of-sample Sharpe ratio of mean-variance portfolios backed by alternative linear factor models. Using a sample of monthly US portfolio returns spanning the period 1968-2016, we ?nd evidence that multifactor linear models have better empirical properties than the CAPM, not only when the cross-section of expected returns is evaluated in-sample, but also when they are used to inform one-month ahead portfolio selection. When we compare portfolios associated to multifactor models with mean-variance decisions implied by the single-factor CAPM, we document statistically signi?cant di¤erences in Sharpe ratios of up to 10 percent. Linear multifactor models that provide the best in-sample ?t also yield the highest realized Sharpe ratios. JEL classi?cation: G11, G12. Keywords: Linear asset pricing models, Stochastic discount factor, Portfolio selection, Out-of-sample performance.

Suggested Citation

  • Massimo Guidolin & Erwin Hansen & Martín Lozano-Banda, 2018. "Portfolio Performance of Linear SDF Models: An Out-of-Sample Assessment," Working Papers 627, IGIER (Innocenzo Gasparini Institute for Economic Research), Bocconi University.
    • Handle: RePEc:igi:igierp:627
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    More about this item

    Keywords

    linear asset pricing models; stochastic discount factor; portfolio selection; out-of-sample performance.;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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