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(Almost) Model‐Free Recovery
Author(s) -
SCHNEIDER PAUL,
TROJANI FABIO
Publication year - 2019
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/jofi.12737
Subject(s) - sharpe ratio , portfolio , conditional variance , econometrics , variance (accounting) , economics , stochastic discount factor , variance risk premium , capital asset pricing model , conditional expectation , kernel (algebra) , market portfolio , mathematics , equity (law) , minimum variance unbiased estimator , financial economics , statistics , combinatorics , volatility risk premium , stochastic volatility , autoregressive conditional heteroskedasticity , volatility (finance) , accounting , political science , law , mean squared error
Under mild assumptions, we recover the model‐free conditional minimum variance projection of the pricing kernel on various tradeable realized moments of market returns. Recovered conditional moments predict future realizations and give insight into the cyclicality of equity premia, variance risk premia, and the highest attainable Sharpe ratios under the minimum variance probability. The pricing kernel projections are often U ‐shaped and give rise to optimal conditional portfolio strategies with plausible market timing properties, moderate countercyclical exposures to higher realized moments, and favorable out‐of‐sample Sharpe ratios.