In-Sample and Out-of-Sample Sharpe Ratios of Multi-Factor Asset Pricing Models

59 Pages Posted: 3 Oct 2019 Last revised: 25 Mar 2024

See all articles by Raymond Kan

Raymond Kan

University of Toronto - Rotman School of Management

Xiaolu Wang

Iowa State University

Xinghua Zheng

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management

Date Written: March 16, 2024

Abstract

Using available return data, many multi-factor asset pricing models present impressive in-sample Sharpe ratios, significantly surpassing that of the market portfolio. Such a performance, however, contradicts the conventional wisdom in finance. Investors cannot realistically attain the in-sample Sharpe ratios. They obtain the out-of-sample Sharpe ratios, which are significantly lower. Estimation risk is one reason for this performance deterioration. We theoretically study the effect of estimation risk by obtaining the exact distributions of in-sample and out-of-sample Sharpe ratios, and argue that such effect needs to be considered in model comparisons.

Keywords: asset pricing model; Sharpe ratio; estimation risk; model comparison; exact and asymptotic distributions; stochastic representation

JEL Classification: C10; C11; G11; G12

Suggested Citation

Kan, Raymond and Wang, Xiaolu and Zheng, Xinghua, In-Sample and Out-of-Sample Sharpe Ratios of Multi-Factor Asset Pricing Models (March 16, 2024). Journal of Financial Economics (JFE), Forthcoming, Available at SSRN: https://ssrn.com/abstract=3454628 or http://dx.doi.org/10.2139/ssrn.3454628

Raymond Kan (Contact Author)

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S3E6
Canada
416-978-4291 (Phone)
416-971-3048 (Fax)

Xiaolu Wang

Iowa State University ( email )

2167 Union Drive
Ames, IA 50011
United States

Xinghua Zheng

Hong Kong University of Science & Technology (HKUST) - Department of Information Systems, Business Statistics and Operations Management ( email )

Clear Water Bay
Kowloon
Hong Kong

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