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RFS Advance Access originally published online on January 19, 2006
Review of Financial Studies 2006 19(2):423-455; doi:10.1093/rfs/hhj015
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© The Author 2006. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For permissions, please email: journals.permissions@oxfordjournals.org.

Evaluating Government Bond Fund Performance with Stochastic Discount Factors

Wayne Ferson
Boston College and NBER

Tyler R. Henry
University of Georgia

Darren J. Kisgen
Boston College

Address correspondence to Wayne Ferson, Boston College, 140 Commonwealth Avenue, Chestnut Hill, MA 02467, or email: wayne.ferson{at}bc.edu.

This article shows how to evaluate the performance of managed portfolios using stochastic discount factors (SDFs) from continuous-time term structure models. These models imply empirical factors that include time averages of the underlying state variables. The approach addresses a performance measurement bias, described by Goetzmann, Ingersoll, and Ivkovic (2000) and Ferson and Khang (2002), arising because fund managers may trade within the return measurement interval or hold positions in replicable options. The empirical factors contribute explanatory power in factor model regressions and reduce model pricing errors. We illustrate the approach on US government bond funds during 1986–2000.


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