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RFS Advance Access published online on January 19, 2006
Review of Financial Studies, 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

Article

Evaluating Government Bond Fund Performance with Stochastic Discount Factors

Wayne Ferson 1 *, Tyler R. Henry 2, and Darren J. Kisgen 3
1 Boston College and NBER
2 University of Washington
3 Boston College

* To whom correspondence should be addressed.
Wayne Ferson, E-mail: wayne.ferson{at}bc.edu


  Abstract

This paper shows how to evaluate the performance of managed portfolios using stochastic discount factors 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 U.S. government bond funds during 1986-2000.


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