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Variable Selection for Portfolio Choice

Author

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  • Yacine AÏT‐SAHALI
  • Michael W. Brandt
Abstract
We study asset allocation when the conditional moments of returns are partly predictable. Rather than first model the return distribution and subsequently characterize the portfolio choice, we determine directly the dependence of the optimal portfolio weights on the predictive variables. We combine the predictors into a single index that best captures time variations in investment opportunities. This index helps investors determine which economic variables they should track and, more importantly, in what combination. We consider investors with both expected utility (mean variance and CRRA) and nonexpected utility (ambiguity aversion and prospect theory) objectives and characterize their market timing, horizon effects, and hedging demands.

Suggested Citation

  • Yacine AÏT‐SAHALI & Michael W. Brandt, 2001. "Variable Selection for Portfolio Choice," Journal of Finance, American Finance Association, vol. 56(4), pages 1297-1351, August.
    • Handle: RePEc:bla:jfinan:v:56:y:2001:i:4:p:1297-1351
    DOI: 10.1111/0022-1082.00369
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • C43 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods: Special Topics - - - Index Numbers and Aggregation

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