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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