Skip to main content
SpringerLink
Log in

Methodologies for Isolating and Assessing the Portfolio Performance Potential of Stock Return Forecast Models with an Illustration

  • Chapter
Handbook of Portfolio Construction

Abstract

This paper develops and illustrates methodology for full sample assessment of the potential ability of a stock returns forecasting model to improve portfolio performance. The methodology maps a cross-section of fractile portfolios formed by rank-ordering on forecasted return into a related cross-section of control-matched fractile portfolios. No cross-sectional variation in controls such as beta, size, tax differences, and growth means no impact on the cross-section of realized returns.

This is a preview of subscription content, log in via an institution to check access.

Access this chapter

Log in via an institution
Chapter
USD 29.95
Price excludes VAT (USA)
  • Available as PDF
  • Read on any device
  • Instant download
  • Own it forever
eBook
USD 169.00
Price excludes VAT (USA)
  • Available as PDF
  • Read on any device
  • Instant download
  • Own it forever
Softcover Book
USD 219.99
Price excludes VAT (USA)
  • Compact, lightweight edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info
Hardcover Book
USD 219.99
Price excludes VAT (USA)
  • Durable hardcover edition
  • Dispatched in 3 to 5 business days
  • Free shipping worldwide - see info

Tax calculation will be finalised at checkout

Purchases are for personal use only

Institutional subscriptions

Preview

Unable to display preview. Download preview PDF.

Unable to display preview. Download preview PDF.

References

  • Adrian, T. and J. Rosenberg. 2008. “Stock Returns and Volatility: Pricing the Short-Run and Longrun Components of Market Risk.” Journal of Finance 63, 2997–3030.

    Article  Google Scholar 

  • Banz, R. 1981. “The Relationship Between Returns and Market Value of Common Stocks.” Journal of Financial Economics 9, 3–18.

    Article  Google Scholar 

  • Basu, S. 1974. The Relationship Between Investment Performance of Equity Securities and Their Price-Earnings Ratios: A Test of the Efficient Market-Expected Return Model. Unpublished Doctoral Dissertation, Cornell University.

    Google Scholar 

  • Basu, S. 1977. “Investment Performance of Common Stocks in Relations to Their Price Earnings Ratios: A Test of Market Efficiency.” Journal of Finance 32, 663–682.

    Article  Google Scholar 

  • Basu, S. 1983. “The Relationship Between Earnings Yield, Market Value and Return for NYSE Common Stocks: Further Evidence.” Journal of Financial Economics 12, 129–156.

    Article  Google Scholar 

  • Bernhard, A. 1959. The Evaluation of Common Stocks. New York: Simon and Schuster.

    Google Scholar 

  • Bloch, M., J.B.Guerard Jr., H.M. Markowitz, P. Todd, and G.L. Xu. 1993. “A Comparison of Some Aspects of the U.S. and Japanese Equity Markets.” Japan & the World Economy 5, 3–26.

    Google Scholar 

  • Blume, M. 1980. “Stock Return and Dividend Yield: Some More Evidence,” Review of Economics and Statistics 62, 567–577.

    Article  Google Scholar 

  • Blume, M.E., M.N. Gultekin, and N.B. Gultekin. 1990. “Validating Return-Generating Models.” Working Paper.

    Google Scholar 

  • Box, G.E.P. 1954. “The Exploration and Exploitation of Response Surfaces.” Biometrica 10, 16–60.

    Article  Google Scholar 

  • Box, G.E.P. and N.R. Draper. 1959. “A Basis for the Selection of a Response Surface Design.” Journal of the American Statistical Association 54, 622–654.

    Article  Google Scholar 

  • Box, G.E.P. and N.R. Draper. 1987. Empirical Model Building and Response Surfaces. New York: Wiley Interscience.

    Google Scholar 

  • Box, G.E.P. and N.R. Draper. 2007. Response Surfaces, Mixtures, and Ridge Analysis. New York: Wiley Interscience.

    Book  Google Scholar 

  • Box, G.E.P., J.S. Hunter, and W.G. Hunter. 2005. Statistics for Experimenters. New York: Wiley Interscience.

    Google Scholar 

  • Brennen, M. 1970. “Taxes, Market Valuation and Financial Policy.” National Tax Journal 23, 417–429.

    Google Scholar 

  • Brown, S.J. 1993. “Nonlinear Systems Estimation: Asset Pricing Model Applications.” In H. Varian (ed.), Economic and Financial Modeling with Mathematica. New York: Springer Verlag.

    Google Scholar 

  • Brown, S.J. 2008. “Elusive Return Predictability: Discussion.” International Journal of Forecasting 24, 19–21.

    Article  Google Scholar 

  • Brown, S.J. and M.I. Weinstein. 1983. “A New Approach to Testing Asset Pricing Models: The Bilinear Paradigm.” Journal of Finance 38, 711–743.

    Article  Google Scholar 

  • Campbell, J.Y., J. Hilscher, and H. Szilagyi. 2008. “In Search of Distress Risk.” Journal of Finance 63, 2899–2939.

    Article  Google Scholar 

  • Chan, L.K.C., N. Jegadeesh, and J. Lakonishok. 1996. “Momentum Strategies.” Journal of Finance 51, 1681–1713.

    Article  Google Scholar 

  • Conner, G., and R.A. Korajczak. 1988. “Risk and Return in an Equilibrium APT: Application of a New Test Methodology.” Journal of Financial Economics 21, 255–289.

    Article  Google Scholar 

  • Conner, G. and R.A. Korajczak. 1993. “A Test for the Number of Factors in an Approximate Factor Model.” Journal of Finance 48, 1263–1291.

    Article  Google Scholar 

  • Cooper, M.J., H. Gulen, and M.J. Schill. “Asset Growth and the Cross-Section of Stock Returns.” Journal of Finance 63, 1609–1651.

    Google Scholar 

  • Dhrymes, P.J., I. Friend, and N.B. Gülteikin. 1984. “A Critical Reexamination of the Empirical Evidence on the Arbitrage Pricing Theory.” Journal of Finance 39, 323–346.

    Article  Google Scholar 

  • Dhrymes, P.J., I. Friend, M.N. Gültekin, and N.B. Gültekin. 1985a. “New Tests of the APT and Their Implications.” Journal of Finance 40, 659–674.

    Article  Google Scholar 

  • Dhrymes, P.J., I. Friend, N.B. Gültekin, and M.N. Gültekin. 1985b. “An Empirical Examination of the Implications of Arbitrage Pricing Theory.” Journal of Banking and Finance 9, 73–99.

    Article  Google Scholar 

  • Dremen, D. 1979. Contrarian Investment Strategy. New York: Random House.

    Google Scholar 

  • Dremen, D. 1998. Contrarian Investment Strategies: The Next Generation. New York: Simon and Schuster.

    Google Scholar 

  • Elton, E.J., M.J. Gruber, and M.W. Padberg. 1979. “Simple Criteria for Optimal Portfolio Selection: The Multi-Index Case.” In E.J. Elton and M.J. Gruber (eds.), Portfolio Theory, 25 Years After: Essays in Honor of Harry Markowitz. Amsterdam: North-Holland.

    Google Scholar 

  • Fama, E.F. and K.R. French. 1988. “Dividend Yields and Expected Stock Returns.” Journal of Financial Economics 22, 3–25.

    Article  Google Scholar 

  • Fama, E.F. and K.R. French. 1992. “Cross-Sectional Variation in Expected Stock Returns.” Journal of Finance 47, 427–465.

    Article  Google Scholar 

  • Fama, E.F. and K.R. French. 1995. “Size and the Book-to-Market Factors in Earnings and Returns. Journal of Finance 50, 131–155.

    Article  Google Scholar 

  • Fama, E.F. and K.R. French. 2008a. “Dissecting Anomalies.” Journal of Finance 63, 1653–1678.

    Article  Google Scholar 

  • Fama, E.F. and K.R. French. 2008b “Average Returns, B/M, and Share Issues,” Journal of Finance 63, 2971–2995.

    Article  Google Scholar 

  • Fama, E.F. and J. MacBeth. 1973. “Risk, Return, and Equilibrium: Empirical Tests.” Journal of Political Economy 81, 607–636.

    Article  Google Scholar 

  • Ferson, W.E. and C.R. Harvey. 1991a. “The Variation of Economic Risk Premiums.” Journal of Political Economy 99, 385–415.

    Article  Google Scholar 

  • Ferson, W.E. and C.R. Harvey. 1991b. “Sources of Predictability in Portfolio Returns.” Financial Analysts Journal 47, 49–56.

    Article  Google Scholar 

  • Ferson, W.E. and C.R. Harvey. 1995. “Explaining the Predictability of Asset Returns.” In A Chen (ed.), Research in Finance 11.

    Google Scholar 

  • Ferson, W.E. and C.R. Harvey. 1998. “Fundamental Determinants of National Equity Market Returns: A Perspective on Conditional Asset Pricing.” Journal of Banking & Finance 21, 1625–1665.

    Article  Google Scholar 

  • Graham, B. and D.L. Dodd. 1934. Security Analysis. New York: McGraw-Hill Book Company.

    Google Scholar 

  • Graham, B., D. Dodd, and S. Cottle. 1962. Security Analysis: Principles and Techniques, 4th edition. New York: McGraw-Hill Book Company.

    Google Scholar 

  • Guerard, J.B. Jr. and S. Chettiappan. 2009. “Stock Selection Modeling and Data Mining Corrections: Long-Only versus 130/30 Models.” This Volume.

    Google Scholar 

  • Guerard, J.B. Jr., M.G. Gultekin, and B.K. Stone. 1997. “The Role of Fundamental Data and Analysts’ Earnings Breadth, Forecasts, and Revisions in the Creation of Efficient Portfolios.” In A. Chen (ed.), Research in Finance 15, 69–91.

    Google Scholar 

  • Hamada, R.S. 1972. “The Effect of the Firm’s Capital Structure on the Systematic Risk of Common Stocks. Journal of Finance 27, 435–452.

    Article  Google Scholar 

  • Haugen R.A. 2001. Modern Investment Theory, 5th edition. Upper Saddle River, NJ: Prentice Hall.

    Google Scholar 

  • Haugen, R.A. 1999. The Inefficient Stock Market, 5th Edition. Upper Saddle River, NJ: Prentice Hall.

    Google Scholar 

  • Haugen, R.A. and N. Baker. 1996. “Communality in the Determinants of Expected Results.” Journal of Financial Economics 41, 401–440.

    Article  Google Scholar 

  • Jaffe, J., D.B. Keim, and R. Westerfield. 1989. “Earnings, Yields, Market Values, and Stock Returns.” Journal of Finance 44, 135–148.

    Article  Google Scholar 

  • Khuri, A.I., and J.A. Cornell. 1996. Response Surfaces: Designs and Analysis. New York: Marcel Dekker, Inc.

    Google Scholar 

  • Lakonishok, J., A. Shleifer, and R.W. Vishny. 1994. “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance 49, 1541–1578.

    Article  Google Scholar 

  • Latane, H.A., D.L. Tuttle, and C.P. Jones. 1975. Security Analysis and Portfolio Management, 2nd Edition. New York: The Roland Press.

    Google Scholar 

  • Lease, R.C., K. John, A. Kalay, U. Loewenstein, and O.H. Sarig. 2000. Dividend Policy: Its Impact on Firm Value. Boston: Harvard Business School Press.

    Google Scholar 

  • Levy, H. 1999. Introduction to Investments. Cincinnati: South-Western College Publishing. Second Edition.

    Google Scholar 

  • Markowitz, H.M. 1952. “Portfolio Selection.” Journal of Finance 7, 77–91.

    Article  Google Scholar 

  • Markowitz, H.M. 1959. Portfolio Selection: Efficient Diversification of Investment. Cowles Foundation Monograph No. 16. New York: Wiley.

    Google Scholar 

  • Markowitz, H.M. 1976. “Investment in the Long Run: New Evidence for an Old Rule.” Journal of Finance 31, 1273–1286.

    Article  Google Scholar 

  • Markowitz, H.M. 1984. “The Two-Beta Trap.” Journal of Portfolio Management 11, 12–19.

    Google Scholar 

  • Markowitz, H.M. 1987. Mean–Variance Analysis in Portfolio Choice and Capital Markets. Oxford: Basil Blackwell.

    Google Scholar 

  • Markowitz, H.M. 1991. “Foundations of Portfolio Theory.” Journal of Finance 46(2), 469–477.

    Article  Google Scholar 

  • Markowitz, H.M. 2000. Mean–Variance Analysis in Portfolio Choice and Capital Markets. New Hope, PA: Frank J. Fabozzi Associates.

    Google Scholar 

  • Markowitz, H.M., and G. Xu. 1994. “Data Mining Corrections.” Journal of Portfolio Management 21, 60–69.

    Article  Google Scholar 

  • Myers, R.H. 1976. Response Surface Methodology. Boston: Allyn & Bacon.

    Google Scholar 

  • Myers, R.H., A.I. Khuri, W.H. Corter Jr. 1989. “Response Surface Methodology: 1966–1988, Technometrics, 31, 137–157.

    Article  Google Scholar 

  • Peterson, P., D. Peterson, and J. Ang. 1985. “Direct Evidence on the Marginal Rate of Taxation on Dividend Income.” Journal of Financial Economics 14, 267–282.

    Article  Google Scholar 

  • Pilotte, E.A. 2003. “Capital Gains, Dividend Yields, and Expected Inflation.” Journal of Finance 58, 447–466.

    Article  Google Scholar 

  • Ramnath, S., S. Rock, and P. Shane. 2008. “The Financial Analyst Forecasting Literature: A Taxonomy with Suggestions for Further Research.” International Journal of Forecasting 24, 34–75.

    Article  Google Scholar 

  • Rosenberg, B. 1974. “Extra-Market Components of Covariance in Security Returns.” Journal of Financial and Quantitative Analysis 9, 263–274.

    Article  Google Scholar 

  • Rosenberg, B., and V. Marathe. 1979. “Tests of Capital Asset Pricing Hypotheses.” In H. Levy (ed.), Research in Finance 1.

    Google Scholar 

  • Rudd, A., and B. Rosenberg. 1979. “Realistic Portfolio Optimization.” In E. Elton and M. Gruber (eds.), Portfolio Theory, 25 Years After. Amsterdam: North-Holland Publishing Co.

    Google Scholar 

  • Rudd, A., and B. Rosenberg. 1980. “The ‘Market Model’ in Investment Management.” Journal of Finance 35, 597–607.

    Article  Google Scholar 

  • Rosenberg, B., and A. Rudd. 1977. “The Yield/Beta/Residual Risk Tradeoff.” Working paper 66. Research Program in Finance, Institute of Business and Economic Research, University of California, Berkeley.

    Google Scholar 

  • Rosenberg, B., and A. Rudd. 1982. “Factor-Related and Specific Returns of Common Stocks: Serial Correlation and Market Inefficiency.” Journal of Finance 37, 543–554.

    Article  Google Scholar 

  • Sharpe, W.F. 1963. “A Simplified Model for Portfolio Analysis.” Management Science 9, 277–293.

    Article  Google Scholar 

  • Sharpe, W.F. 1964. “Capital Asset Prices: A Theory of Market Equilibrium Under Conditions of Risk” Journal of Finance 19, 425–442.

    Article  Google Scholar 

  • Sharpe, W.F. 1967. “A Linear Programming Algorithm for Mutual Fund Portfolio Selection.” Management Science 13, 449–510.

    Article  Google Scholar 

  • Sharpe, W.F. 1971. “A Linear Programming Approximation for the General Portfolio Problem.” Journal of Financial and Quantitative Analysis 6, 1263–1275.

    Article  Google Scholar 

  • Stone, B.K. 1973. “A Linear Programming Formulation of the General Portfolio Selection Problem.” Journal of Financial and Quantitative Analysis 8, 621–636.

    Article  Google Scholar 

  • Stone, B.K. 2003. “Rank-Based Security Grouping, Multicolinearity, and the Assessment of Cross-Sectional Return Dependencies,” Working Paper. The Marriott School of Management, Brigham Young University.

    Google Scholar 

  • Stone, B.K., D.L. Adolphson, and T.W. Miller. 1993. “Optimal Data Selection and Grouping: An Extension of Traditional Response Surface Methodology to Observational Studies Involving Noncontrolled Empirical Data Generation.” Advances in Mathematical Programming and Financial Planning. 3, 39–68.

    Google Scholar 

  • Stowe, J.D., T.R. Robinson, J.E. Pinto, D.W. McLeavey. 2002. Analysis of Equity Investments: Valuation. Charlottesville, VA: Association for Investment Management and Research.

    Google Scholar 

  • Stowe, J.D., T.R. Robinson, J.E. Pinto, D.W. McLeavey. 2007. Equity Asset Valuation. Hoboken NJ: John Wiley & Sons for CFA Institute and Association for Investment Management and Research.

    Google Scholar 

  • Timmerman, A. 2008a. “Elusive Return Predictability.” International Journal of Forecasting 24, 1–18.

    Article  Google Scholar 

  • Timmerman, A. 2008b. “Reply to Discussion of Elusive Return Predictability.” International Journal of Forecasting 24, 29–30.

    Article  Google Scholar 

  • Williams, J.B. 1938. The Theory of Investment Value. Cambridge: HarvardUniversity Press.

    Google Scholar 

  • Ziemba, W.T. 1991 “Fundamental Factors in US and Japanese Stock Returns.” Berkeley Program in Finance.

    Google Scholar 

Download references

Author information

Authors and Affiliations

  1. Marriott School, Brigham Young University, Utah, 84602, Provo

    Bernell K. Stone

  2. McKinley Capital Management, LLC, 3301 C Street, Suite 500, Anchorage, AK, 99503, USA

    John B. Guerard Jr.

Authors
  1. Bernell K. Stone
    View author publications

    You can also search for this author in PubMed Google Scholar

  2. John B. Guerard Jr.
    View author publications

    You can also search for this author in PubMed Google Scholar

Corresponding author

Correspondence to Bernell K. Stone .

Editor information

Editors and Affiliations

  1. McKinley Capital Management, LLC, 3301 C. Street, Anchorage, AK, 99503, USA

    John B. Guerard Jr.

Rights and permissions

Reprints and permissions

Copyright information

© 2010 Springer Science+Business Media, LLC

About this chapter

Cite this chapter

Stone, B.K., Guerard, J.B. (2010). Methodologies for Isolating and Assessing the Portfolio Performance Potential of Stock Return Forecast Models with an Illustration. In: Guerard, J.B. (eds) Handbook of Portfolio Construction. Springer, Boston, MA. https://doi.org/10.1007/978-0-387-77439-8_10

Download citation

Publish with us

Policies and ethics

Search

Navigation