Tell me and I forget, teach me and I remember, involve me and I learn.
In this chapter we use historical data to formulate models of stock returns and test the performance of hypothetical portfolios based on the models. Building and testing models with past data in this way is referred to as backtesting. Backtesting is used widely in quantitative equity portfolio management (QEPM) as a first step in evaluating how well a new investment idea might work. The results of a backtest show whether a strategy would have worked over a significant period in the recent past, which might give an indication of how it will work in the near and not-so-near future.
A series of decisions must ...