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Predicting Market Components Out of Sample:
Asset Allocation Implications

Aiguo Kong, David E. Rapach, Jack K. Strauss and Guofu Zhou
The Journal of Portfolio Management Summer 2011, 37 (4) 29-41; DOI: https://doi.org/10.3905/jpm.2011.37.4.029
Aiguo Kong
is a professor of finance at Fudan University in Shanghai, China.
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  • For correspondence: agkong@fudan.edu.cn
David E. Rapach
is an associate professor of economics at Saint Louis University in St. Louis, MO.
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  • For correspondence: rapachde@slu.edu
Jack K. Strauss
is the Simon Professor of Economics at Saint Louis University in St. Louis, MO.
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  • For correspondence: strausjk@slu.edu
Guofu Zhou
is the Frederick Bierman and James E. Spears Professor of Finance at Washington University in St. Louis, MO.
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  • For correspondence: zhou@wustl.edu
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Abstract

The authors analyze out-of-sample return predictability for components of the aggregate market, focusing on the well-known Fama–French size/value-sorted portfolios. Employing a forecast combination approach based on a variety of economic variables and lagged component returns as predictors, they find significant evidence of out-of-sample return predictability for nearly all component portfolios. Moreover, return predictability is typically much stronger for small-cap/high book-to-market value stocks. The pattern of component return predictability is enhanced during business cycle recessions, linking component return predictability to the real economy. Considering various component-rotation investment strategies, the authors show that out-of-sample component return predictability can be exploited to substantially improve portfolio performance.

TOPICS: Portfolio construction, exchanges/markets/clearinghouses, statistical methods

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The Journal of Portfolio Management: 37 (4)
The Journal of Portfolio Management
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Summer 2011
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Predicting Market Components Out of Sample:
Asset Allocation Implications
Aiguo Kong, David E. Rapach, Jack K. Strauss, Guofu Zhou
The Journal of Portfolio Management Jul 2011, 37 (4) 29-41; DOI: 10.3905/jpm.2011.37.4.029

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Predicting Market Components Out of Sample:
Asset Allocation Implications
Aiguo Kong, David E. Rapach, Jack K. Strauss, Guofu Zhou
The Journal of Portfolio Management Jul 2011, 37 (4) 29-41; DOI: 10.3905/jpm.2011.37.4.029
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