Eliminating Look-Ahead Bias in Evaluating Persistence in Mutual Fund Performance

Posted: 4 Jan 2006

See all articles by Jenke ter Horst

Jenke ter Horst

TIAS School for Business and Society

Marno Verbeek

Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM); Netspar

Theo Nijman

Tilburg University - Tilburg University School of Economics and Management

Abstract

Performance persistence studies typically suffer from ex-post conditioning biases. As stressed by Carhart (1997a) and Carpenter and Lynch (1999), standard methods of analysis on a survivorship free sample are subject to look-ahead biases. In this paper, we show how one can easily correct for look-ahead bias using weights based on probit regressions.

First, we model how survival probabilities depend upon historical returns, fund age and aggregate economy-wide shocks, using two samples of US based 'income' and 'growth' funds. Subsequently, we employ a Monte Carlo study to analyze the size and shape of the look-ahead bias in performance persistence that arise when a survivorship free sample is used with standard techniques. In particular, we show that look-ahead bias induces a spurious U-shaped pattern in performance persistence. Finally, we demonstrate how a weighting procedure based upon probit regressions can be used to correct for this bias. In this way, we obtain look-ahead bias-corrected estimates of abnormal performance relative to a one-factor and the Carhart (1997b) four-factor model, as well as its persistence. The results suggest that in this sample, look-ahead bias is of minor importance and does not seriously affect estimates of persistence. Our bias-corrected results closely correspond to the findings of Carhart (1997b), implying that there is no evidence on a risk-adjusted basis for persistence in performance.

Keywords: mutual funds, performance evaluation, look-ahead bias

JEL Classification: G11, G23, C34

Suggested Citation

ter Horst, Jenke R. and Verbeek, Marno and Nijman, Theo E., Eliminating Look-Ahead Bias in Evaluating Persistence in Mutual Fund Performance. Journal of Empirical Finance, Vol. 8, pp. 345-373, September 2001, Available at SSRN: https://ssrn.com/abstract=873515

Jenke R. Ter Horst

TIAS School for Business and Society ( email )

Warandelaan 2
TIAS Building
Tilburg, Noord Brabant 5037 AB
Netherlands

Marno Verbeek (Contact Author)

Erasmus University - Rotterdam School of Management ( email )

P.O. Box 1738
Room T09-53
3000 DR Rotterdam
Netherlands
+31 10 408 2790 (Phone)

HOME PAGE: http://www.rsm.nl/mverbeek

Erasmus Research Institute of Management (ERIM)

P.O. Box 1738
3000 DR Rotterdam
Netherlands

Netspar

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Theo E. Nijman

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2342 (Phone)
+31 13 466 3280 (Fax)

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