Targets, Predictability, and Performance
Francisco Peñaranda, Liuren Wu
Management Science · 2022 · Volume 68 · Issue 2
Abstract
We study market-timing strategies on a given portfolio to achieve a particular risk or return target. Targeting a constant risk level leads to increasing investment at better investment opportunities, whereas targeting a constant expected return does the opposite. Theoretical and numerical analysis shows that within the usual ranges of investment opportunities, risk targeting generates better unconditional performance than return targeting across a wide range of metrics. Empirical analysis with commonly constructed stock portfolios further highlights the practical infeasibility of return targeting due to the inherently low out-of-sample predicting power. By contrast, risk targeting tends to enhance unconditional stability and performance. This paper was accepted by Kay Giesecke, finance.
Keywords
market timing, return targeting, risk targeting, Sharpe ratio, information ratio
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