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

Abstract

If a risk-based portfolio is optimal, managers can reverse engineer the portfolio to learn what type of expected returns are compatible with the assumption that this portfolio is optimal. Those reverse-engineered return forecasts are the implied expected returns. In their article, Implied Expected Returns and the Choice of a Mean–Variance Efficient Portfolio Proxy , David Ardia of Laval University and Kris Boudt of Vrije Universiteit Brussel show that these implied expected returns are reasonable and potentially useful from a practical perspective.

Their research shows that, over time, using implied expected returns and risk-based portfolios as a benchmark provides more accurate predictions and allows portfolio managers to conduct fewer portfolio changes than when a typical market-cap-weighted portfolio is used.

TOPICS: Portfolio management/multi-asset allocation, factor-based models