Implied Expected Returns and the Choice of a Mean–Variance Efficient Portfolio Proxy

Abstract

Implied expected returns are the expected returns for which a supposedly mean–variance efficient portfolio is effectively efficient, given a covariance matrix. The authors analyze the properties of monthly implied expected stock returns and study their sensitivity to the choice of mean–variance efficient portfolio proxy. For the universe of S&P 100 stocks over the period from 1984 to 2014, they find that using as risk-based portfolio proxy with respect to a market capitalization or fundamental value portfolio brings its biggest gains in return forecasts’ stability and precision. For all the proxies considered, they report that the implied expected returns outperform forecasts based on a time-series model in stability and precision.