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Time-Varying Sharpe Ratios and Market Timing

11 Sep 2011

Article by: Robert F. Whitelaw
Published by: NYU, Stern School of Business
Date: 19 Nov 1997

“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
this predictability can generate Sharpe ratios more than 70% larger than a buy-and-hold strategy.”

Full article (PDF): Link

 
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