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Hindsight Effects in Dollar-Weighted Returns

Published online by Cambridge University Press:  20 March 2014

Simon Hayley
Simon Hayley*
Affiliation:
simon.hayley.1@city.ac.uk, Cass Business School, City University London, 106 Bunhill Row, London, EC1Y 8TZ, United Kingdom.
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Abstract

A growing number of studies use dollar-weighted (DW) returns as evidence that bad timing substantially reduces investor returns, and that consequently the equity risk premium must be considerably lower than previously thought. This paper demonstrates that this method is subject to a hindsight effect (as prior returns influence levels of new investment) and derives a technique that corrects it. The results show that for mainstream U.S. equities, DW returns are low because of this hindsight effect (bad investor timing had very little impact). Thus, low DW returns do not imply that the risk premium is correspondingly low.

Information

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 49 , Issue 1 , February 2014 , pp. 249 - 269
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2014 

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