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Robust performance hypothesis testing with the Sharpe ratio


Ledoit, Olivier; Wolf, Michael (2008). Robust performance hypothesis testing with the Sharpe ratio. Journal of Empirical Finance, 15(5):850-859.

Abstract

Applied researchers often test for the difference of the Sharpe ratios of two investment strategies. A very popular tool to this end is the test of Jobson and Korkie (1981), which has been corrected by Memmel (2003). Unfortunately, this test is not valid when returns have tails heavier than the normal distribution or are of time series nature. Instead, we propose the use of robust inference methods. In particular, we suggest to construct a studentized time series bootstrap confidence interval for the difference of the Sharpe ratios and to declare the two ratios different if zero is not contained in the obtained interval. This approach has the advantage that one can simply resample from the observed data as opposed to some null-restricted data. A simulation study demonstrates the improved finite
sample performance compared to existing methods. In addition, two applications to real data are provided.

Abstract

Applied researchers often test for the difference of the Sharpe ratios of two investment strategies. A very popular tool to this end is the test of Jobson and Korkie (1981), which has been corrected by Memmel (2003). Unfortunately, this test is not valid when returns have tails heavier than the normal distribution or are of time series nature. Instead, we propose the use of robust inference methods. In particular, we suggest to construct a studentized time series bootstrap confidence interval for the difference of the Sharpe ratios and to declare the two ratios different if zero is not contained in the obtained interval. This approach has the advantage that one can simply resample from the observed data as opposed to some null-restricted data. A simulation study demonstrates the improved finite
sample performance compared to existing methods. In addition, two applications to real data are provided.

Citations

99 citations in Web of Science®
139 citations in Scopus®
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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
03 Faculty of Economics > Department of Economics
Dewey Decimal Classification:330 Economics
Language:English
Date:December 2008
Deposited On:04 Dec 2008 15:47
Last Modified:05 Apr 2016 12:37
Publisher:Elsevier
ISSN:0927-5398
Publisher DOI:https://doi.org/10.1016/j.jempfin.2008.03.002

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