Frequency-domain information for active portfolio management

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Title: Frequency-domain information for active portfolio management
Author: Faria, Gonçalo ; Verona, Fabio
Organization: Bank of Finland
Series: Bank of Finland Research Discussion Papers
ISSN: 1456-6184
Series year: 2020
Series number: 2/2020
Year of publication: 2020
Publication date: 9.1.2020
Pages: 39
Subject (yso): arvopaperit; riskit; ennustettavuus; osakkeet; joukkovelkakirjat; ennusteet
Keywords: arvopaperisijoitukset; riskipreemiot
JEL: C58; G11; G17
Other keywords: equity risk premium; bond risk premium; multiresolution analysis; active portfolio management; predictability
Abstract: We assess the benefits of using frequency-domain information for active portfolio management. To do so, we forecast the bond risk premium and equity risk premium using a methodology that isolates frequencies (of the predictors) with the highest predictive power. The resulting forecasts are more accurate than those of traditional forecasting methods for both asset classes. When used in the context of active portfolio management, the forecasts based on frequency-domain information lead to better portfolio performances than when using the original time series of the predictors. It produces higher information ratio (0.57 vs 0.45), higher CER gains (1.12% vs 0.81%), and lower maximum drawdown (19.1% vs 19.6%).

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