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RFS Advance Access originally published online on September 13, 2006
Review of Financial Studies 2008 21(5):2243-2274; doi:10.1093/rfs/hhl034
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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

Biases in Decomposing Holding-Period Portfolio Returns

Weimin Liu
University of Nottingham, UK

Norman Strong
University of Manchester, UK

Address correspondence to Weimin Liu, Nottingham University Business School, Accounting and Finance Division, University of Nottingham, Nottingham, NG8 1BB, UK, or e-mail: weimin.liu{at}nottingham.ac.uk

JEL Classification: G10


  Abstract

A growing number of studies in finance decompose multiperiod portfolio returns into a series of single-period returns, using these to test asset pricing models or market efficiency or to evaluate the returns to investment strategies such as those based on momentum, size, and value–growth. We provide a formal analysis of the decomposition method. Crucially, we argue and present empirical evidence that some methods researchers use involve portfolios that nobody would seriously consider ex ante, that transactions costs associated with such portfolios make them poor investment vehicles, and that they can lead to spurious statistical inferences.

We thank Martin Walker, Ser-Huang Poon, Ian Garrett, Alex Taylor, Philip Brown, the anonymous referee, participants at the 18th Australasian Finance and Banking Conference (Sydney, December 2005), and seminar participants at Manchester Business School for helpful comments. We are particularly grateful for the insightful comments and suggestions of the editor Matthew Spiegel.


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