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Title: Least Squares Predictions and Mean-Variance Analysis

Author(s): Enrique Sentana

Publication Date: February 1999

Keyword(s): Forecasting, Market timing strategies, Portfolio Allocation and Sharpe Ratios

Programme Area(s): Financial Economics

Abstract: We compare the Sharpe ratios of investment funds which combine one riskless and one risky asset following: i) timing strategies which forecast excess returns using simple regressions; ii) a strategy which uses multiple regression instead; and iii) a passive allocation which combines the funds in i) with constant weightings. We show that iii) dominates i) and ii), as it implicitly uses the linear forecasting rule that maximises the Sharpe ratio of actively traded portfolios, but the relative ranking of i) and ii) is generally unclear. We also discuss under what circumstances the performance of ii) and iii) coincides.

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Bibliographic Reference

Sentana, E. 1999. 'Least Squares Predictions and Mean-Variance Analysis'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=2088