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Rev Fin 1995; 8:1-53
© 1995 the Society for Financial Studies

Article

Bayesian inference and portfolio efficiency

S Kandel1, R McCulloch2 and RF Stambaugh3
1 Tel-Aviv University, Tel-Aviv, Israel and University of Pennsylvania, Pennsylvania, USA
2 University of Chicago, Chicago, USA
3 University of Pennsylvania, Pennsylvania, USA and National Bureau of Economic Research, USA

Abstract

A Bayesian approach is used to investigate a sample's information about a portfolio's degree of inefficiency. With standard diffuse priors, posterior distributions for measures of portfolio inefficiency can concentrate well away from values consistent with efficiency, even when the portfolio is exactly efficient in the sample. The data indicate the that the NYSE-AMEX market portfolio is rather inefficient in the presence of a riskless asset, although this conclusion is justified only after an anslysis using informative priors. Including a riskless asset significantly reduces any sample's ability to produce posterior distributions supporting small degrees of inefficiency.


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