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Time-varying Sharpe ratios and market timing

By Robert F. Whitelaw, Matt Richardson and Time-varying Sharpe Ratios

Abstract

This paper documents predictable time-variation in stock market Sharpe ratios. Predetermined nancial variables are used to estimate both the conditional mean and volatility of equity returns, and these moments are combined to estimate the conditional Sharpe ratio. In sample, estimated conditional Sharpe ratios show substantial time-variation that coincides with the variation in ex post Sharpe ratios and with the phases of the business cycle. Generally, Sharpe ratios are low at the peak of the cycle and high at the trough. In out-of-sample analysis, using 10-year rolling regressions, we can identify periods in which the ex post Sharpe ratio is approximately three times larger than its full-sample value. Moreover, relatively naive market-timing strategies that exploit The empirical literature contains a wealth of evidence on predictable variation in the mean and volatility of equity returns. 1 Given the joint predictability of the mean and volatility, it is perhaps somewhat surprising that the literature has been relatively silent on predictable variation in equit

Year: 1997
OAI identifier: oai:CiteSeerX.psu:10.1.1.196.2642
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