NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Data-Snooping Biases in Tests of Financial Asset Pricing Models

Andrew W. Lo, A. Craig MacKinlay

NBER Working Paper No. 3001 (Also Reprint No. r1538)
Issued in March 1991
NBER Program(s):   ME

We investigate the extent to which tests of financial asset pricing models may be biased by using properties of the data to construct the test statistics. Specifically, we focus on tests using returns to portfolios of common stock where portfolios are constructed by sorting on some empirically motivated characteristic of the securities such as market value of equity. We present both analytical calculations and Monte Carlo simulations that show the effects of this type of data-snooping to be substantial. Even when the sorting characteristic is only marginally correlated with individual security statistics, 5 percent tests based on sorted portfolio returns may reject with probability one under the null hypothesis. This bias is shown to worsen as the number of securities increases given a fixed number of portfolios, and as the number of portfolios decreases given a fixed number of securities. We provide an empirical example that illustrates the practical relevance of these biases.

download in pdf format
   (519 K)

email paper

This paper is available as PDF (519 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Published: The Review of Financial Studies, Vol. 3, No. 3, pp. 431-467, (1990).

Users who downloaded this paper also downloaded these:
LeBaron w5505 Technical Trading Rule Profitability and Foreign Exchange Intervention
Lo and MacKinlay w2960 An Econometric Analysis of Nonsynchronous Trading
Lo and MacKinlay w2168 Stock Market Prices Do Not Follow Random Walks: Evidence From a Simple Specification Test
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us