Publication Type

Journal Article

Version

submittedVersion

Publication Date

8-2010

Abstract

This paper proposes a way to allow Bayesian priors to reflect the objectives of an economic problem. That is, we impose priors on the solution to the problem rather than on the primitive parameters whose implied priors can be backed out from the Euler equation. Using monthly returns on the Fama-French 25 size and book-to-market portfolios and their 3 factors from January 1965 to December 2004, we find that investment performances under the objective-based priors can be significantly different from those under alternative priors, with differences in terms of annual certainty-equivalent returns greater than 10% in many cases. In terms of an out-of-sample loss function measure, portfolio strategies based on the objective-based priors can substantially outperform both strategies under alternative priors and some of the best strategies developed in the classical framework.

Keywords

Portfolio choice, Parameter uncertainty, Bayesian priors

Discipline

Finance and Financial Management | Portfolio and Security Analysis

Research Areas

Finance

Publication

Journal of Financial and Quantitative Analysis

Volume

45

Issue

4

First Page

959

Last Page

986

ISSN

0022-1090

Identifier

10.1017/S0022109010000335

Publisher

Cambridge University Press

Copyright Owner and License

Authors

Additional URL

https://doi.org/10.1017/S0022109010000335

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