Paper #1146

Title:

Understanding portfolio efficiency with conditioning information

Author:

Francisco Peñaranda

Date:

January 2009 (Revised: October 2011)

Abstract:

We show that unconditionally efficient returns do not achieve the maximum unconditional Sharpe ratio, neither display zero unconditional Jensen’s alphas, when returns are predictable. Next, we define a new type of efficient returns that is characterized by those unconditional properties. We also study a different type of efficient returns that is rationalized by standard mean-variance preferences and motivates new Sharpe ratios and Jensen’s alphas. We revisit the testable implications of asset pricing models from the perspective of the three sets of efficient returns. We also revisit the empirical evidence on the conditional variants of the CAPM and the Fama-French model from a portfolio perspective.

Keywords:

Conditional CAPM, Dynamic portfolio strategies, Jensen's alpha, Mean-variance frontiers, Representing portfolios, Sharpe ratio

JEL codes:

C12, G11, G12

Area of Research:

Finance and Accounting

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