Does survivorship bias really matter? An empirical investigation into its effects on the mean reversion of share returns on the JSE (1984–2007)

Abstract

This paper tests for the impact of survivorship bias by building on the work of Cubbin, Eidne, Firer and Gilbert (2006), and Bailey and Gilbert (2007). The former paper confirmed the existence of mean reversion of relative returns on the JSE, because portfolios of shares with high Price to Earnings (P/E) ratios (being those which had tended to outperform recently) underperformed significantly over five years against portfolios of shares with low P/E ratios. This definition of mean reversion is contentious, but the convention is followed. The latter paper confirmed the economic validity of this conclusion by applying liquidity constraints to portfolio formation. This tended to slightly dampen the observed effects, but confirmed the significant presence of mean reversion. In both cases, extensive efforts were made to include all delisted shares in the study to avoid the effects of survivorship bias. This paper updates both studies by extending the period for a further 21 months, and then quantifies the impact of survivorship bias by comparing the results against those of an equivalent study based on a data set of currently listed shares only. The results of our study confirm that, in general, the effects of survivorship bias are present and material. While similar patterns of mean reversion are detected on both data sets, the returns earned on portfolios selected from currently listed shares are significantly higher than the corresponding returns on portfolios selected from all shares. While survivorship bias does not necessarily affect the conclusion of the patterns of mean reversion revealed in the earlier studies, it is a potentially important issue in any empirical financial research, and effort ought to be made to avoid it.

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