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Performance Evaluation with Stochastic Discount Factors

  • Heber Farnsworth
  • Wayne E. Ferson
  • David Jackson
  • Steven Todd

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.

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File URL: http://www.nber.org/papers/w8791.pdf
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 8791.

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Date of creation: Feb 2002
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Publication status: published as Farnsworth, Heber, Wayne Ferson, David Jackson and Steven Todd. "Performance Evaluation With Stochastic Discount Factors," Journal of Business, 2002, v75(3,Jul), 473-503.
Handle: RePEc:nbr:nberwo:8791
Note: AP
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