Analyst Shelly King is using a returns and earnings database to examine the past performance of stocks. King sorts stocks from high to low P/E ratio by dividing the beginning of the year stock price by the reported year-end earnings per share recorded in the database for the prior year. King then creates portfolios of high P/E stocks and low P/E stocks and compares their performance. King’s research design most likely suffers from:
A) time period bias.
B) data mining bias.
C) look-ahead bias.
Explanation
C is correct
King has designed a trading strategy based on P/E ratios. All the necessary accounting information must be available in order to implement the strategy. At the beginning of a new year, the earnings from the recently ended fiscal year will not be released for several weeks and perhaps months into the new year. By assuming the fiscal year-end earnings are available at the beginning of the new fiscal year, King is introducing a look-ahead bias into her research design. Time period bias refers to a research design in which results are time-specific and cannot be generalized reliably outside the sample period. Data mining bias refers to the likelihood that in repeated testing of data for various strategies or patterns, eventually a pattern will emerge by chance.
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