Backtesting

Abstract

Empirical Finance is in crisis: Our most important "discovery" tool is historical simulation, and yet, most backtests published in leading Financial journals are flawed.

The problem is well-known to professional organizations of Statisticians and Mathematicians, who have publicly criticized the misuse of mathematical tools among Finance researchers. In particular, reported results are not corrected for multiple testing. To this day, standard Econometrics textbooks seem oblivious to the issue of multiple testing. This may invalidate a large portion of the work done over the past 70 years.

We present practical solutions to this problem.

This presentation is related to papers http://ssrn.com/abstract=2308659, http://ssrn.com/abstract=2326253, http://ssrn.com/abstract=2460551, http://ssrn.com/abstract=2507040 and http://ssrn.com/abstract=2597421.

Keywords: backtest, historical simulation, probability of backtest over-fitting, investment strategy, optimization, Sharpe ratio, minimum backtest length, performance degradation

JEL Classification: G0, G1, G2, G15, G24, E44