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FRM Part I · FRM Exam Part I · Fund Management

Which statement about hedge fund performance measurement and biases is correct?

Survivorship bias overstates average reported returns. Funds that failed and closed are removed from databases, so the surviving sample looks better than the true population. The other statements reverse the direction of the biases.

  1. ASurvivorship bias overstates reported average hedge fund returns because defunct funds drop out of databasesCorrect
  2. BBackfill bias understates returns because funds only report after poor performance
  3. CSmoothing of illiquid asset prices overstates reported volatility and understates Sharpe ratios
  4. DSelf-selection bias causes databases to overstate losses because only weak funds report

Explanation

When failed funds disappear from databases, the remaining sample shows higher average returns. Backfill bias also overstates returns because funds typically begin reporting after good results. Smoothing understates volatility and thus overstates Sharpe ratios, so the other options reverse the direction.

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