Speed of Adjustment in U.S. Financial Markets

Abstract

This study uses U.S. financial market data from the post-World War II era to examine whether the statistical evidence supports a flexible-weight asset allocation in U.S. financial markets. A variety of econometric tests are developed to estimate the speed of adjustment of economic time series data subject to unit roots and structural breaks. The findings suggest that successful flexible-weight asset allocation is likely to be difficult. Of all the relationships tested, only the long-term government bonds versus S&P 500 relationship is cointegrated with a significant speed of adjustment parameter. This suggests a predictable long-run equilibrium relationship.

TOPICS: Portfolio construction, factors, risk premia, portfolio theory