On Timing The Market: The Empirical
Probability Assessment Approach With An Inflation Adapter
Robert R. Grauer and Nils H. Hakansson
Worldwide Asset and Liability Modeling (eds. John Mulvey and William
Ziemba), Cambridge University Press, 1998, 149-181.
Recent studies have documented varying degrees of predictability and mean
reversion in stock returns but the question of how they might be exploited remains
relatively open. This article applies dynamic portfolio theory to the construction
and rebalancing of portfolios principally composed of stocks and cash or borrowing.
Probability assessments were based on (all moments of) recent past returns, both
in raw form and with an inflation adapter. The inflation adapter had little impact
prior to the mid-sixties but markedly improved realized portfolio returns over the
1966-88 subperiod. Some excess returns exceeded one percent per quarter but the
various performance tests applied reached contradictory conclusions concerning over
which period the null hypothesis should be rejected.
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