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Stock weighting and nontrading bias in estimated portfolio returns

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  • Philip Gray
  • David Gallagher

Abstract

type="main" xml:id="acfi12014-abs-0001"> Liu and Strong (2008) note that researchers often employ a simple (but incorrect) averaging approach that induces significant error into estimated buy-and-hold portfolio returns. This study explores the additional challenges that arise when stocks are subject to nontrading. We develop a decomposition of the total bias in estimated return into the components attributable to the stock weighting approach and the treatment of nontrading. While the latter is shown to be negligible, the former can approach 150 basis points per month. Our empirical analysis of Australian equities shows that the simple averaging approach tends to overstate the size and book-to-market effects, and understate the momentum effect.

Suggested Citation

  • Philip Gray & David Gallagher, 2014. "Stock weighting and nontrading bias in estimated portfolio returns," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 54(2), pages 467-503, June.
    • Handle: RePEc:bla:acctfi:v:54:y:2014:i:2:p:467-503
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    File URL: http://hdl.handle.net/10.1111/acfi.2014.54.issue-2
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    Citations

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    Cited by:

    1. Comerton-Forde, Carole & Do, Binh Huu & Gray, Philip & Manton, Tom, 2016. "Assessing the information content of short-selling metrics using daily disclosures," Journal of Banking & Finance, Elsevier, vol. 64(C), pages 188-204.
    2. Tian, Xiao & Do, Binh & Duong, Huu Nhan & Kalev, Petko S., 2015. "Liquidity provision and informed trading by individual investors," Pacific-Basin Finance Journal, Elsevier, vol. 35(PA), pages 143-162.
    3. Gray, Philip & Liao, Iris Siyu & Strydom, Maria, 2018. "The profitability of trading NOA and accruals: One effect or two?," International Review of Financial Analysis, Elsevier, vol. 58(C), pages 211-224.
    4. Zhong, Angel & Limkriangkrai, Manapon & Gray, Philip, 2014. "Anomalies, risk adjustment and seasonality: Australian evidence," International Review of Financial Analysis, Elsevier, vol. 35(C), pages 207-218.
    5. Chung, Yi-Tsai & Hsu, Chuan-Hao & Ke, Mei-Chu & Liao, Tung Liang & Chiang, Yi-Chein, 2016. "The weakening value premium in the Australian and New Zealand stock markets," Pacific-Basin Finance Journal, Elsevier, vol. 36(C), pages 123-133.
    6. Hoang, Khoa & Cannavan, Damien & Gaunt, Clive & Huang, Ronghong, 2019. "Is that factor just lucky? Australian evidence," Pacific-Basin Finance Journal, Elsevier, vol. 57(C).
    7. Mardy Chiah & Philip Gharghori & Angel Zhong, 2020. "Comovement in Anomalies between the Australian and US Equity Markets," International Review of Finance, International Review of Finance Ltd., vol. 20(4), pages 1005-1017, December.
    8. Zhong, Angel & Gray, Philip, 2016. "The MAX effect: An exploration of risk and mispricing explanations," Journal of Banking & Finance, Elsevier, vol. 65(C), pages 76-90.
    9. Angel Zhong, 2022. "Institutional trading in stock market anomalies in Australia," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(1), pages 893-930, March.
    10. Xiaoyue Chen & Bin Li & Andrew C. Worthington, 2022. "Economic uncertainty and Australian stock returns," Accounting and Finance, Accounting and Finance Association of Australia and New Zealand, vol. 62(3), pages 3441-3474, September.
    11. Mardy Chiah & Daniel Chai & Angel Zhong & Song Li, 2016. "A Better Model? An Empirical Investigation of the Fama–French Five-factor Model in Australia," International Review of Finance, International Review of Finance Ltd., vol. 16(4), pages 595-638, December.
    12. Vitali Alexeev & Katja Ignatieva, 2021. "Biases in variance of decomposed portfolio returns," International Review of Finance, International Review of Finance Ltd., vol. 21(4), pages 1152-1178, December.
    13. Mai, Van Anh (Vivian) & Ang, Tze Chuan ‘Chewie’ & Fang, Victor, 2016. "Aggregate volatility risk and the cross-section of stock returns: Australian evidence," Pacific-Basin Finance Journal, Elsevier, vol. 36(C), pages 134-149.

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