Portfolio Efficiency and Discount Factor Bounds with Conditioning Information: An Empirical Study

37 Pages Posted: 24 Jul 2003

See all articles by Devraj Basu

Devraj Basu

SKEMA Business School - Lille Campus

Alexander Stremme

University of Warwick - Finance Group

Date Written: February 2003

Abstract

In this paper, we study the properties of unconditionally efficient portfolios and discount factor bounds in the presence of conditioning information. The main contribution of this paper is to provide a detailed comparison between various stochastic discount factor bounds with conditioning information. We do this by exploiting the explicit link between the stochastic discount factor approach and portfolio efficiency in the presence of conditioning information. For common choices of base assets and conditioning instruments, we find that the "unconditionally efficient" bounds of Ferson and Siegel (2002) are statistically indistinguishable from the (theoretically) optimal bounds of Gallant, Hansen, and Tauchen (1990), while having smaller sampling variability. We demonstrate that the difference in sampling variability of the UE and GHT bounds is due to the different behavior of the portfolio weights underlying their construction. Our work is closely related to and extends Ferson and Siegel (2001), Ferson and Siegel (2002) and Bekaert and Liu (2001).

Suggested Citation

Basu, Devraj and Stremme, Alexander, Portfolio Efficiency and Discount Factor Bounds with Conditioning Information: An Empirical Study (February 2003). EFA 2003 Annual Conference Paper No. 591, Cass Business School Research Paper, WBS Finance Group Research Paper No. 29, Available at SSRN: https://ssrn.com/abstract=423962 or http://dx.doi.org/10.2139/ssrn.423962

Devraj Basu

SKEMA Business School - Lille Campus ( email )

Avenue Willy Brandt, Euralille
Lille, 59777
France

Alexander Stremme (Contact Author)

University of Warwick - Finance Group ( email )

Gibbet Hill Rd
Coventry, CV4 7AL
Great Britain
+44 (0) 2476 - 522 066 (Phone)
+44 (0) 2476 - 523 779 (Fax)

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