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Escaping the backtesting illusion


Hens, Thorsten; Schenk-Hoppé, Klaus Reiner; Woesthoff, Mathis-Hendrik (2020). Escaping the backtesting illusion. Journal of Portfolio Management, 46(4):81-93.

Abstract

Two tests can help asset managers to develop more robust investment strategies: an impact test and a survival test. Both tests complement the backtest, in which one checks how a proposed investment strategy would have performed in the past. The impact test considers the performance of the strategy when assets under management grow (crowdedness), and it checks the impact that growth in assets under management in competing strategies has on the proposed strategy (cross impact). The survival test considers the effect of the long-term evolution of assets under management in competition for market capital. Using Shiller’s S&P 500 index and bond market data, we show that time-series momentum (relative strength) performs best in the backtest and the impact test but that an expected relative cash-flow rule (relative dividend yield) has the best long-term survival properties.

Abstract

Two tests can help asset managers to develop more robust investment strategies: an impact test and a survival test. Both tests complement the backtest, in which one checks how a proposed investment strategy would have performed in the past. The impact test considers the performance of the strategy when assets under management grow (crowdedness), and it checks the impact that growth in assets under management in competing strategies has on the proposed strategy (cross impact). The survival test considers the effect of the long-term evolution of assets under management in competition for market capital. Using Shiller’s S&P 500 index and bond market data, we show that time-series momentum (relative strength) performs best in the backtest and the impact test but that an expected relative cash-flow rule (relative dividend yield) has the best long-term survival properties.

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Additional indexing

Item Type:Journal Article, refereed, original work
Communities & Collections:03 Faculty of Economics > Department of Banking and Finance
Dewey Decimal Classification:330 Economics
Scopus Subject Areas:Social Sciences & Humanities > Accounting
Social Sciences & Humanities > General Business, Management and Accounting
Social Sciences & Humanities > Finance
Social Sciences & Humanities > Economics and Econometrics
Language:English
Date:1 March 2020
Deposited On:16 Nov 2020 18:11
Last Modified:28 Feb 2021 08:07
Publisher:Institutional Investor
ISSN:0095-4918
OA Status:Closed
Publisher DOI:https://doi.org/10.3905/jpm.2019.1.123
Other Identification Number:merlin-id:19306

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