Robert F. Whitelaw
ABSTRACT
This paper documents predictable time-variation in stock market Sharpe
ratios. Predetermined financial variables are used to estimate both the
conditional mean and volatility of equity returns, and these moments are
combined to estimate the conditional Sharpe ratio. In sample, estimated
conditional Sharpe ratios show substantial time-variation that coincides
with the variation in ex post Sharpe ratios and with the phases of the
business cycle. Generally, Sharpe ratios are low at the peak of the cycle
and high at the trough. In out-of-sample analysis, using 10-year rolling
regressions, we can identify periods in which the ex post Sharpe ratio
is approximately three times larger than it full-sample value. Moreover,
relatively naïve market-timing strategies that exploit this predictability
can generate Sharpe ratios more than 70% larger than a buy-and-hold strategy.
Subject: Investments/predictability of asset returns, investments/portfolio choice (Empirical)
Whitelaw: (212) 998-0338 rwhitela@stern.nyu.edu
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