Asset Pricing Models: Implications for Expected Returns and Portfolio Selection

A. Craig MacKinlay and Lubos Pastor

No 7162, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: Implications of factor-based asset pricing models for estimation of expected returns and for portfolio selection are investigated. In the presence of model mispricing due to a missing risk factor, the mispricing and the residual covariance matrix are linked together. Imposing a strong form of this link leads to expected return estimates that are more precise and more stable over time than unrestricted estimates. Optimal portfolio weights that incorporate the link when no factors are observable are proportional to expected return estimates, effectively using an identity matrix as a covariance matrix. The resulting portfolios perform well both in simulations and in out-of-sample comparisons.

JEL-codes: G1 (search for similar items in EconPapers)
Date: 1999-06
New Economics Papers: this item is included in nep-fin
Note: AP
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Citations: View citations in EconPapers (5)

Published as MacKinlay, A. Craig and L. Pastor. "Asset Pricing Models: Implications For Expected Returns And Portfolio Selection," Review of Financial Studies, 2000, v13(4,Winter), 883-916.

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Related works:
Journal Article: Asset Pricing Models: Implications for Expected Returns and Portfolio Selection (2000)
Working Paper: Asset Pricing Models: Implications for Expected Returns and Portfolio Selection
Working Paper: Asset Pricing Models: Implications for Expected Returns and Portfolio Selection
Working Paper: Asset Pricing Models: Implications for Expected Returns and Portfolio Selection
Working Paper: Asset Pricing Models: Implications for Expected Returns and Portfolio Selection
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