Lars Kaiser

Enhanced Mean-Variance Portfolios: A Controlled Integration of Quantitative Predictors

The intuitiveness and practicality of mean–variance portfolios largely depend on the accuracy of moment estimates, which are subject to large estimation errors and are conditional on time. The authors propose a model that accounts for factor dynamics in a Bayesian setting, in which they endogenously derive the effect of estimation accuracy on the posterior distribution from a linear predictive regression model. By doing so, they capture upside return potential for periods of high factor-explained variance, while constraining downside risk for periods of low predictive quality. Results are robust in a simulation and an empirical setting.

International Equity Indexes and Public Trust

This article makes use of a unique dataset accounting for public trust towards alternative institutions within 27 countries, thereby yielding a local perspective on the trustworthiness of governments, the media, and the business environment as a whole. The results indicate that this local perspective adds potential value for forming rational investment decisions in a global setting that are not distorted by foreign perspectives. The author takes the perspective of a U.S. investor by considering U.S. dollar–denoted international equity indices and building trust-based portfolios, which are compared to traditional market-capitalization-weighted, GDP-weighted, ΔGDP-weighted, and equal-weighted portfolio schemes. They show that accounting for trust does entail valuable information for international equity allocation, especially with respect to fast-growing emerging economies.

Forecasting Quality of Professionals: Does Affiliation Matter?

Economists fulfilling a public mission – namely academics, Fed and government employees – demonstrate a tendency towards being pessimistic, whereas bankers in general are overly optimistic about future stock market developments. We show that these characteristics are of particular relevance and statistically significant during economic recessions and stock market downturns. Whilst investment bankers have always shown a tendency towards being optimistic, other affiliations are increasingly following their footsteps and most dominantly so for short-term forecasts. Especially during the most recent crises, their expectations of fast rebounds remained largely unsatisfied, questioning the applicability of economists’ forecasts as we move forward.

Style, Momentum and ESG Investing

This study provides finer-grained results on the financial effectiveness of ESG integration for mainstream active investment styles. We account for firm size, industry and country effects within ESG scores and introduce the concept of ESG risk materiality. Empirical evidence shows that US and European investors can raise their portfolio’s ESG level and increase risk-adjusted performance at the same time. Therefore, we add to the growing demand for sustainable products in the traditional investment industry and overcome the notion of ESG integration being a burden to traditional investment strategies.

Higher Moments Matter! Cross-Sectional (Higher) Moments and the Predictability of Stock Returns

In this paper we investigate the predictive power of cross-sectional volatility, skewness and kurtosis for future stock returns. Adding to the work of Maio (2015), who finds cross-sectional volatility to forecast a decline in the equity premium with high predictive power in-sample as well as out-of-sample, we highlight the additional role of cross-sectional skewness and cross-sectional kurtosis. We find cross-sectional skewness to deliver a significant contribution to the performance of cross-sectional volatility in the short run (less than 12 months forecasts), while cross-sectional skewness and cross-sectional kurtosis contribute significantly to the performance of cross-sectional volatility at horizons greater than 12 months. Furthermore, we document a clear benefit of including higher moments when disaggregating excess market returns along the value and size dimension. In this case, both cross-sectional skewness and cross-sectional kurtosis span the predictive quality towards large-cap and growth stocks. Overall, the addition of higher order cross-sectional moments significantly improves the predictive performance of cross-sectional volatility, a variable that is already regarded as having high predictive power with respect to the equity premium.

Research Note: The Economic Benefit of Forecasting Market Components for Mean-Variance Investors

Existing studies focus on variables’ predictive quality with respect to the aggregated stock market, which per definition contains a minimum level of idiosyncratic risk and provides a favorable environment for such applications. Economic intuition suggests that the level of out-of-sample predictability decreases as we climb down the ladder from market aggregates to industries and ultimately single stock returns. Thereon, we ask the central question: Do forecasting errors from direct predictions of market components out-way the additional errors introduced by an intermediary asset pricing model? This is an early stage research note and we welcome any feedback and comments.

Categorical Evaluation of Alternative Index Weighting Schemes

The direction of this study is not to derive a conclusion on the superiority of single strategies from a pure risk-return perspective, but rather provide a guideline on a more accurate and representative categorisation on index weighting schemes. We start of by defining three categories of index construction methods and, thereon, allocate 16 alternative index weighting schemes. Empirical evidence confirms commonalities amongst peers in terms of the distributions of returns, portfolio concentration, a range of risk metrics and a return attribution analysis according to traditional and newly introduced industry-based risk factors. Furthermore, we consider static and dynamic norm constraints to shift sampling approaches closer to the pre-defined benchmark, whilst determining the impact of a substitution from the classical value-weight point of reference to an equally-weighted benchmark portfolio.