Combination Return Forecasts and Portfolio Allocation with the Cross-Section of Book-to-Market Ratios*

Illiquidity and stock returns: cross-section and time-series effects

Andrew Detzel and Jack Strauss

Review of Finance, 2018, vol. 22, issue 5, 1949-1973

Abstract: In this paper, we forecast industry returns out-of-sample using the cross-section of book-to-market (BM) ratios and investigate whether investors can exploit this predictability in portfolio allocation. Cash-flow and return forecasting regressions show that cross-industry BM ratios contain significant predictive information beyond aggregate and industry-specific BM ratios. Forecast combination methods based on industry BM ratios generate significant out-of-sample predictability for many industries. Real-time portfolio-rotation strategies that buy industries with high predicted returns and short industries with low predicted returns based on combination forecasts earn significant alpha with respect to standard asset pricing models net of transaction costs.

Keywords: Industry return predictability; Portfolio allocation; Book-to-market ratio (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (3)

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