E2009_4 - Cardiff Economics Working Papers Guangjie Li The...

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Unformatted text preview: Cardiff Economics Working Papers Guangjie Li The Horizon Effect of Stock Return Predictability and Model Uncertainty on Portfolio Choice: UK Evidence E2009/4 CARDIFF BUSINESS SCHOOL WORKING PAPER SERIES This working paper is produced for discussion purpose only. These working papers are expected to be published in due course, in revised form, and should not be quoted or cited without the authors written permission. Cardiff Economics Working Papers are available online from: http://www.cardiff.ac.uk/carbs/econ/workingpapers Enquiries: EconWP@cardiff.ac.uk ISSN 1749-6101 March 2009 Cardiff Business School Cardiff University Colum Drive Cardiff CF10 3EU United Kingdom t: +44 (0)29 2087 4000 f: +44 (0)29 2087 4419 www.cardiff.ac.uk/carbs The Horizon Effect of Stock Return Predictability and Model Uncertainty on Portfolio Choice: UK Evidence * Guangjie LI Economics Department University of Leicester University Road Leicester LE1 7RH Abstract We study how stock returns predictability and model uncertainty af- fect a rational buy-and-hold investors decision to allocate her wealth for different lengths of investment horizons in the UK market. We consider the FTSE All-Share Index as the risky asset, and the UK Treasury bill as the riskless asset in forming the investors portfolio. We identify the most powerful predictors of the stock return by accounting for model un- certainty. We find that though stock return predictability is weak, it can still affect the invesors optimal portfolio decision over different invest- ment horizons. JEL Classification Code: C39, G11 Keywords: Bayesian Model Averaging, SUR model, stock return pre- dictability, portfolio choice * The author wishes to thank Gary Koop, Rodney Strachan, Roberto Gonzalez and Se- bastiano Manzan for their helpful comments and encouragement. All remaining errors are entirely the authors. email address: gl41@le.ac.uk 1 1 Introduction Finance advisors often tell people with long investment horizon to invest more into stocks than bonds. Fund managers will recommend different portfolios to investors with different investment horizons. For example, they may recommend some stock shares for long term investment and some others just for short term. Such ideas to allocate wealth according to the length of investment horizon have been challenged by academics. Early work about horizon effect can be seen in Samuelson (1969) and Merton (1969), in which they prove that if the return of a risky asset is unpredictable, rational investors should choose the same portfolio regardless of the length of their investment. More recently, Samuelson (1989) and Samuelson (1990) readdressed the irrelevance of the length of investment horizon in portfolio management....
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E2009_4 - Cardiff Economics Working Papers Guangjie Li The...

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