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The Journal of Portfolio Management

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Being Honest in Backtest Reporting: A Template for Disclosing Multiple Tests

Frank J. Fabozzi and Marcos López de Prado
The Journal of Portfolio Management Fall 2018, 45 (1) 141-147; DOI: https://doi.org/10.3905/jpm.2018.45.1.141
Frank J. Fabozzi
is professor of finance in the EDHEC Business School in Nice, France
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Marcos López de Prado
is a principal and the head of machine learning at AQR Capital Management LLC, in Greenwich, CT, and a lecturer at Cornell University in Ithaca, NY
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Abstract

Selection bias under multiple testing is a serious problem. From a practitioner’s perspective, failure to disclose the impact of multiple tests of a proposed investment strategy to clients and senior management can lead to the adoption of a false discovery. Clients will lose money, senior management will misallocate resources, and the firm may be exposed to reputational, legal, and regulatory risks. From the perspective of academic journals that publish evidence supporting an investment strategy, the failure to address selection bias under multiple testing threatens to invalidate large portions of the literature in empirical finance. In this article, the authors propose a template that practitioners should use to fairly disclose multiple tests involved in an alleged discovery when pitching strategies to clients and senior management. The same template could be used by contributors to academic journals so that referees, and ultimately readers, can assess the strategy. By disclosing this information, those who are charged with making the final decision about a discovery can evaluate the probability that the purported discovery is false.

TOPICS: Statistical methods, factors, risk premia

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The Journal of Portfolio Management: 45 (1)
The Journal of Portfolio Management
Vol. 45, Issue 1
Fall 2018
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Being Honest in Backtest Reporting: A Template for Disclosing Multiple Tests
Frank J. Fabozzi, Marcos López de Prado
The Journal of Portfolio Management Oct 2018, 45 (1) 141-147; DOI: 10.3905/jpm.2018.45.1.141

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Being Honest in Backtest Reporting: A Template for Disclosing Multiple Tests
Frank J. Fabozzi, Marcos López de Prado
The Journal of Portfolio Management Oct 2018, 45 (1) 141-147; DOI: 10.3905/jpm.2018.45.1.141
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  • Article
    • Abstract
    • ERROR TYPES: MISSED OPPORTUNITY ERRORS AND FALSE DISCOVERY ERRORS
    • THE PROBLEM WITH SBuMT
    • REPORTING AND CORRECTING FOR MULTIPLE TESTING
    • CONCLUSION
    • ACKNOWLEDGMENTS
    • ENDNOTES
    • REFERENCES
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  • PDF (Subscribers Only)

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