FoundationMultiple choice
A backtest too good to be true · Part 1 of 3
A colleague’s daily stock-selection model uses company fundamentals and shows a Sharpe ratio of 4 from 2005 to 2020. The universe is today’s S&P 500 constituents, and each fundamental is stamped with its fiscal period end date.
What is the first problem to raise?
- ASurvivorship bias from using today’s index members
- BA Sharpe of 4 is plausible for a daily strategy, so there is nothing to raise yet
- CFive hundred stocks is too few for a cross-sectional model
- DFifteen years of history is too short to estimate anything
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