Performance Evaluation with Stochastic Discount Factors

50 Pages Posted: 14 Feb 2002 Last revised: 4 Apr 2022

See all articles by Heber Farnsworth

Heber Farnsworth

Rice University

Wayne E. Ferson

University of Southern California; National Bureau of Economic Research (NBER)

David Jackson

Carleton University - Eric Sprott School of Business

Steven K. Todd

Loyola University of Chicago

Multiple version iconThere are 3 versions of this paper

Date Written: February 2002

Abstract

We study the use of stochastic discount factor (SDF) models in evaluating the investment performance of portfolio managers. By constructing artificial mutual funds with known levels of investment ability, we evaluate a large set of SDF models. We find that the measures of performance are not highly sensitive to the SDF model, and that most of the models have a mild negative bias when performance is neutral. We use the models to evaluate a sample of U.S. equity mutual funds. Adjusting for the observed bias, we find that the average mutual fund has enough ability to cover its transactions costs. Extreme funds are more likely to have good rather than poor risk adjusted performance. Our analysis also reveals a number of implementation issues relevant to other applications of SDF models.

Suggested Citation

Farnsworth, Heber and Ferson, Wayne E. and Jackson, David and Todd, Steven K., Performance Evaluation with Stochastic Discount Factors (February 2002). NBER Working Paper No. w8791, Available at SSRN: https://ssrn.com/abstract=300753

Heber Farnsworth

Rice University ( email )

6100 South Main Street
Houston, TX 77005-1892
United States

Wayne E. Ferson (Contact Author)

University of Southern California ( email )

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Los Angeles, CA 90089
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HOME PAGE: http://www-rcf.usc.edu/~ferson/

National Bureau of Economic Research (NBER)

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David Jackson

Carleton University - Eric Sprott School of Business ( email )

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Steven K. Todd

Loyola University of Chicago ( email )

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United States
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(312) 915-8508 (Fax)

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