On the performance of efficient portfolios

This paper investigates the performance of efficient portfolios in a financial market with heterogeneous investors including rational traders, noise traders, and chartists. A generalization of the security market line result states that, regardless of the diversity of beliefs, the portfolios of rational investors with mean-variance preferences are mean-variance efficient in the sense of classical CAPM. We show that, depending on the noise traders' behavior, the performance of efficient portfolios when measured by empirical Sharpe ratios can be dominated. Empirical Sharpe ratios may thus be inappropriate indicators for efficient portfolios.