CFA Level I · CFA Level I Exam · Benchmarking Returns
A benchmark index is reconstituted annually by dropping stocks that have performed poorly and adding stocks that have performed well, and historical index returns are then reported using the current constituents. Which bias is most likely present in the reported index history?
Survivorship bias is most likely present. Using only current constituents omits companies that failed or were dropped after poor performance, so the reported historical index returns are biased upward. A manager compared with such a benchmark may look worse than they actually were.
- ASurvivorship bias, which overstates historical returnsCorrect
- BLook-ahead bias, which understates historical risk only
- CStale pricing bias, which overstates historical volatility only
Explanation
Reporting history using only the securities that remain, or that were added after succeeding, excludes losers and so overstates past returns. This is survivorship bias. The distractors misidentify both the bias and its effect.
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