Bayesian Portfolio Mean-Variance Efficiency Test with Sampling Error of Sharpe Ratio

Lie-Jane Kao, Huei Ching Soo and Cheng Few Lee

Chapter 93 in Handbook of Investment Analysis, Portfolio Management, and Financial Derivatives:In 4 Volumes, 2024, pp 3077-3098 from World Scientific Publishing Co. Pte. Ltd.

Abstract: This study proposes a Bayesian test for a test portfolio p’s mean-variance efficiency that takes into account the sampling errors associated with the ex-post Sharpe ratio ŜR of the test portfolio p. The test is based on the Bayes factor that compares the joint likelihoods under the null hypothesis H0 and the alternative H1. Using historical monthly return data of ten industrial portfolios and a test portfolio, namely, the CRSP value-weighted index, from January 1941 to December 1973 and January 1980 to December 2012, the power function of the proposed Bayesian test is compared to the conditional multivariate F test by Gibbons et al. (1989) and the Bayesian test by Shanken (1987). In an independent simulation study, the performance of the proposed Bayesian test is also demonstrated.

Keywords: Financial Accounting; Financial Auditing; Mutual Funds; Hedge Funds; Asset Pricing; Options; Portfolio Analysis; Risk Management; Investment Analysis; Momentum Analysis; Behavior Analysis; Futures; Index Futures; CDCs; Financial Econometrics; Statistics; Financial Derivatives; Financial Accounting (search for similar items in EconPapers)
JEL-codes: G1 G11 G12 G3 M41 M42 (search for similar items in EconPapers)
Date: 2024
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