Stock return serial dependence and out-of-sample portfolio performance Articles uri icon

publication date

  • April 2014

start page

  • 1031

end page

  • 1073

issue

  • 4

volume

  • 27

international standard serial number (ISSN)

  • 0893-9454

electronic international standard serial number (EISSN)

  • 1465-7368

abstract

  • We study whether investors can exploit serial dependence in stock returns to improve out-of-sample portfolio performance. We show that a vector-autoregressive (VAR) model captures stock return serial dependence in a statistically significant manner. Analytically, we demonstrate that, unlike contrarian and momentum portfolios, an arbitrage portfolio based on the VAR model attains positive expected returns regardless of the sign of asset return cross-covariances and autocovariances. Empirically, we show, however, that both the arbitrage and mean-variance portfolios based on the VAR model outperform the traditional unconditional portfolios only for transaction costs below ten basis points.

keywords

  • expected returns; cross-autocorrelations; security returns; market; momentum; investment; model; predictability; overreaction; optimization