15 Jul 2020

ARP - Backtesting

Alternative Risk Premia (ARP) strategies are typically developed using historical simulations or back-testing. This memo discusses some of the challenges of this process and provides a framework to assess back-testing results.

Back-testing applies the strategy to historic data and assesses how the strategy would have performed in the past. There are a number of challenges that need to be addresses and asset managers need a framework in place to assess these results.

In this memo we discuss:

  • The challenges of overfitting vs underfitting biases in strategy development
  • A framework to assess back-testing results including that back-testing does not equal past performance, detecting statistical overfitting bias, assessing underlying assumptions, back-testing time series and back-testing results vs actual performance
  • Key questions for investors to ask during due diligence processes