CFA Level I · CFA Level I Exam · Hedge Funds
A hedge fund index is built only from funds that choose to report their results to a database. Funds that have performed poorly often stop reporting and are dropped from the database. The index return is most likely overstated because of:
The overstatement is best described as survivorship bias. Funds that perform poorly drop out of the database, so historical index returns reflect only the surviving, stronger funds. This raises average reported returns and understates the risk, unlike backfill bias, which relates to history added when a fund joins.
- Asurvivorship bias.Correct
- Bbackfill bias.
- Cstale pricing bias.
Explanation
When poorly performing funds stop reporting and disappear from the database, only the stronger funds remain in historical averages. This is survivorship bias and it inflates reported returns. Backfill bias concerns the addition of a new fund's prior history, and stale pricing concerns illiquid valuations.
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