Analyzing the Performance of Multifactor Investment Strategies under a Multiple Testing Framework

Abstract

Evaluating portfolios based on numerous combinations of factors using the individual backtesting method could suffer from serious data mining bias and lead to spurious significant findings. Accordingly, the authors employ a multiple hypothesis testing method to examine the multifactor portfolio’s performance. Their empirical results show that even after they adjust for the multiple comparisons bias, stock-picking strategies with certain combined firm characteristics could generate significantly better liquidity risk–adjusted returns. In addition, the outperforming multifactor strategies that the authors report are robust to alternative definitions of factors. However, they observe that the number of significantly profitable multifactor portfolios has decreased substantially in the era of increased liquidity and trading activity in the U.S. stock market.