Risk and Return Properties of Portfolios Based on Directional Forecasts

Abstract

In this study, a formula is derived for the period specific beta (market risk) for a portfolio of financial assets that has been formed on the basis of directional forecasts. This is an important contribution to the literature since measuring the risk of an actively managed portfolio is problematic due to the fact that managers may change fund risk conditional on market expectations. The period‐specific nature of the measure is a significant advantage since historical fund returns are not required and the beta is not influenced by prior fund returns' deviations from the bench mark. The methodology employed allows for the development of a time series of fund betas that permits investigation into a number of important empirical issues. This study is also of practical interest from the perspective of risk management and for both portfolio performance and attribution. Finally, there are many active strategies based on directional forecasts and the approach used here encompasses a significant proportion of these.

Citation

Wilkens, K.A., Heck, J.L. and Cochran, S.J. (2005), "Risk and Return Properties of Portfolios Based on Directional Forecasts", Managerial Finance, Vol. 31 No. 8, pp. 58-76. https://doi.org/10.1108/03074350510769811