Bridge over ocean
1 May 1991 Financial Analysts Journal Volume 47, Issue 3

Sources of Predictability in Portfolio Returns

  1. Wayne E. Ferson
  2. Campbell R. Harvey

Despite the random walk hypothesis, which asserts that asset returns should be completely unpredictable, it is well known that returns are predictable to some extent. Does this predictability reflect inefficiencies such as market fads, or is it more systematic?

A multi-beta asset pricing model using risk factors related to the stock market, unexpected inflation, consumer expenditures and interest rates indicates that most of the predictable variation in asset returns can be explained by shifts in the assets’ risk exposures (betas) and by shifts in the market’s compensations for holding these exposures (risk premiums). Little variation remains to be explained by market inefficiency.

Both betas and risk premiums change predictably over time, although changes in risk premiums are far more important than changes in betas, at least at the portfolio level. The evidence suggests that investors rationally update their assessments of expected return. It also suggests that the relative contributions of different risk factors to predictable return will differ across assets.

Read the Complete Article in Financial Analysts Journal Financial Analysts Journal CFA Institute Member Content

We’re using cookies, but you can turn them off in Privacy Settings.  Otherwise, you are agreeing to our use of cookies.  Accepting cookies does not mean that we are collecting personal data. Learn more in our Privacy Policy.