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RFS Advance Access published online on January 12, 2009
Review of Financial Studies, doi:10.1093/rfs/hhn112
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© The Author 2009. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oxfordjournals.org

Testing Portfolio Efficiency with Conditioning Information

Wayne E. Ferson
University of Southern California and NBER

Andrew F. Siegel
University of Washington

Send correspondence to Wayne E. Ferson, 3670 Trousdale Parkway, Suite 308, Los Angeles, CA 90089-0804; telephone: (213)-740-5615; E-mail: ferson{at}usc.edu.

JEL Classification: G11, G12, G23


  Abstract

We develop asset pricing models’ implications for portfolio efficiency with conditioning information in the form of lagged instruments. A model identifies a portfolio that should be minimum-variance efficient with respect to the conditioning information. Our framework refines tests of portfolio efficiency by using the given conditioning information optimally. The optimal use of the lagged variables is economically important; by using the instruments optimally, we reject several efficiency hypotheses that are not otherwise rejected. The Sharpe ratios of a sample of hedge fund indexes appear consistent with the optimal use of conditioning information.

This article has benefited from comments of the Editor, Tobias Moskowitz, an anonymous referee, from Tom George and Jay Shanken, from the Grant I. Butterbaugh Professorship at the Foster School of Business at the University of Washington and from workshops at the 2000 Pacific Northwest Finance Conference, the 2001 Western Finance Association, the Thirteenth Annual Conference on Financial Economics and Accounting/Fifth Maryland Finance Symposium (2002), the 2003 American Finance Association, and at the following universities: Arizona, Arizona State, Berkeley, UCLA, the Copenhagen Business School, CUNY Baruch, INSEAD, Iowa, McGill, New York University, the Norwegian School of Economics, the Norwegian School of Business, Penn State, Stanford, Toronto, Washington, and Wisconsin.


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