Targets, Predictability, and Performance
2020
We study market-timing strategies on a given portfolio to achieve a particular risk or return target. Targeting a constant risk level leads to increasing investment at better investment opportunities whereas targeting a constant expected return does the opposite. Theoretical and numerical analysis shows that, within the usual ranges of investment opportunities, risk targeting generates better unconditional performance than return targeting across a wide range of metrics. Empirical analysis with commonly constructed stock portfolios further highlights the practical infeasibility of return targeting due to the inherently low out-of-sample predicting power. By contrast, risk targeting tends to enhance unconditional stability and performance.
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