Empirical studies of the modern theories of bond pricing typically choose proxies for the state variables in a rather arbitrary fashion. This paper empirically analyzes the question of the optimal spot rates to use as state variables. The authors' findings indicate that the four-year spot rate serves as the best proxy in the one-state-variable model. In the case of the two-state-variables model, the six-year rate and eight-month rate are identified as best. Tests of the out-of-sample prediction ability indicate that their model is superior to F. R. Macaulay's duration model and alternative proxies for state variables.

In this article we have reviewed “Modern Portfolio Analysis” and outlined some important topics for further research. Issues discussed include the history and future of portfolio theory, the key inputs necessary to perform portfolio optimization, specific problems in applying portfolio theory to financial institutions, and the methods for evaluating how well portfolios are managed. Emphasis is placed on both the history of major concepts and where further research is needed in each of these areas.

Despite the size and importance of separately managed accounts (SMAs) and collective investment trusts, their characteristics and performance have not been studied in detail. We show that separate account performance is similar to that of index funds and superior to that of actively managed mutual funds. Management supplies a benchmark for each separate account. When the management-selected benchmark is used to measure performance, performance is significantly overstated. Despite this, investors react to differences in performance from the management-preferred benchmark in choosing among SMAs. Finally we find variables that explain both the cross section of alphas and the cross section of cash flows.

In this paper, the authors use monthly holdings to study timing ability. These data differ from holdings data used in previous studies in that the authors’ data have a higher frequency and include a full range of securities, not just traded equities. Using a one-index model, the authors find, as do two recent studies, that management appears to have positive and statistically significant timing ability. When a multiindex model is used, the authors show that timing decisions do not result in an increase in performance, whether timing is measured using conditional or unconditional sensitivities. The authors show that sector rotation decisions with respect to high-tech stocks are a major contribution to negative timing.