Value Versus Glamour: The Journal of Finance Vol. Lviii, No. 5 OCTOBER 2003

THE JOURNAL OF FINANCE VOL. LVIII, NO.
5 OCTOBER 2003
Value versus Glamour
JENNIFER CONRAD, MICHAEL COOPER, and GAUTAM KAUL n
ABSTRACT
The fragility of the CAPM has led to a resurgence of research that frequently
uses trading strategies based on sorting procedures to uncover relations be-
tween ¢rm characteristics (such as ‘‘value’’ or ‘‘glamour’’) and equity returns.
We examine the propensity of these strategies to generate statistically and
economically signi¢cant pro¢ts due to our familiarity with the data. Under
plausible assumptions, data snooping can account for up to 50 percent of the
in-sample relations between ¢rm characteristics and returns uncovered using
single (one-way) sorts. The biases can be much larger if we simultaneously
condition returns on two (or more) characteristics.
THE DEBATE AROUND THE EMPIRICAL SUPPORT for the one-factor Capital Asset Pricing
Model (CAPM) in explaining the cross section of expected returns of ¢nancial
securities has led to resurgence of empirical research aimed at discovering vari-
ables that might better explain the behavior of returns.This research has, at least
in part, been given theoretical validity by both the intertemporal version of the
CAPM (see, e.g., Merton (1973)) and the Arbitrage Pricing Theory (see Ross
(1976), Connor (1984)). However, with little guidance from theory on the identity
of the ‘‘factors’’ that determine returns, for the most part, the goal of this litera-
ture is the discovery of multiple characteristics, such as ‘‘value’’ versus ‘‘glamour,’’
that are statistically related to asset returns.
The resurgence of this literature started about two decades ago with tests by
Banz (1981) and Reinganum (1981) that use ¢rm size, in addition to a ¢rm’s beta, to
explain the cross section of required returns on equity. More recently, a series of
papers by Fama and French (1992, 1993, 1995, 1996, 1998) on value versus glamour
stocks has made this issue a central focus of the profession. These papers, and
numerous others, present evidence that multiple relative characteristics of value
n
Conrad is at Kennan-Flagler Business School, Cooper is at Krannert Graduate School of
Management, and Kaul is from University of Michigan Business School. We appreciate the
comments and suggestions made by Joshua Coval, Keith Crocker, Kenneth French, Ravi Ja-
gannathan, Nejat Seyhun, an anonymous referee and Rick Green (the editor), and seminar
participants at the University of Michigan and by our discussant, Tobias Moskowitz, and
other participants at the Western Finance Association Meetings, 1999. We thank Patti Lam-
parter for her help with preparing this document.
1969
1970 The Journal of Finance
versus glamour stocks can explain large fractions of the variability in asset re-
turns.1
Given this backdrop, a good question to ask is: To what extent are the ¢ndings
on value versus glamour characteristics subject to data-snooping biases? The
purpose of this paper is to gauge the impact of data snooping on empirical ¢nd-
ings that are based on a speci¢c and commonly used sorting methodology to un-
cover relations between equity returns and multiple ¢rm characteristics. Many
studies sort variables into portfolios based on speci¢c ¢rm characteristics and
report the subsequent period’s returns/pro¢ts deriving from trading strategies
that are long and short in some subset of these portfolios. Most signi¢cantly,
based on the belief that asset returns are determined by multiple factors, there
is a uniformly increasing tendency for researchers to simultaneously sort re-
turns on more than a single ¢rm characteristic.2 In fact, value and glamour have
both come to signify multiple attributes.
Inadvertent snooping is inherent to this literature because: (a) any new re-
search endeavor is conditioned on the collective knowledge built up to that
point;3 (b) there is no explicit guidance from theory regarding both the number
and the identities of the characteristics related to average returns; and, conse-
quently, (c) we are particularly susceptible to the bias of retaining the ¢ndings
that ‘‘work’’and discarding the ones that do not.
We choose 15 ¢rm characteristics that have been successfully used in previous
studies to uncover cross-sectional di¡erences in returns.We measure the in-sam-
ple relations between these variables and returns measured over subsequent time
periods, and interpret these relations to be a re£ection of mispricing (rather than
rewards for risk taking). We conduct both one-way and two-way sorts on the 15
characteristics, recognizing that the analysis of the two-way sorts is more perti-
nent to the research ¢ndings presented in most studies. Since the chosen ¢rm
characteristics have already been shown to ‘‘work,’’ we then attempt to gauge
the e¡ects of our collective snooping on the in-sample pro¢tability of the trading
1
A partial list of papers in this literature includes Ball (1978), Banz (1981), Reinganum (1981),
Sharpe (1982), Basu (1983), Chen, Roll, and Ross (1983), Keim (1983), Rosenberg, Reid, and Lan-
stein (1985), Bhandari (1988), Ja¡ee, Keim, and Wester¢eld (1989), Chan, Hamao, and Lako-
nishok (1991), Fama and French (1992, 1993, 1995, 1996, 1998), Capaul, Rowley, and Sharpe
(1993), La Porta (1993), Davis (1994), Lakonishok, Shleifer, and Vishny (1994), Breen and Kor-
ajczyk (1995), Chan, Jegadeesh, and Lakonishok (1995), Kothari, Shanken, and Sloan (1995),
Claessens, Dasgupta, and Glen (1996), Daniel and Titman (1997), Kothari and Shanken
(1997), and Chan, Karceski, and Lakonishok (1998). We distinguish between papers that docu-
ment the relation(s) between expected returns and cross-sectional variables and direct tests
of the CAPM/APT (see, e.g., Black, Jensen, and Scholes (1972), Fama and MacBeth (1973), Roll
and Ross (1980), Gibbons (1982), Stambaugh (1982), and Connor and Korajczyk (1986)).
2
While two-way sorts have become the norm, even three-way sorts have been used in the
literature (see, e.g., Chan, Hamao, and Lakonishok (1991) and Daniel and Titman (1997)).
3
Denton (1985), Ross (1987), Lo and MacKinlay (1990), Black (1993a, 1993b), Foster, Smith,
and Whaley (1997), and Sullivan, Timmermann, and White (1999) also emphasize how we
(usually out of sheer necessity) collectively condition our studies on existing empirical regula-
rities with the unintended consequence of snooping the data.
Value versus Glamour 1971
strategies.We devise four measures of data snooping that measure the proportion
of ‘‘real’’pro¢ts observed in-sample that can be generated by performing a plausible
number of searches over ‘‘random characteristics.’’ The di¡erences among the
four measures hinge on the degree of familiarity that the researcher/trader is
assumed to have with the data.
Our in-sample tests and simulation exercises collectively show that inadver-
tent snooping biases, perhaps based on our collective familiarity of the data, have
the potential to explain a signi¢cant fraction, but not all, of the in-sample pro¢ts
of strategies based on one-way sorts. Securities need to be sorted into an unrea-
listically large number of portfolios (50) for snooping to explain more than 50
percent of the pro¢ts. Since most studies sort securities into 10 portfolios, we
conclude that about 50 percent of the in-sample pro¢ts reported in single-sort
studies are ‘‘real.’’
The evidence for the two-way sorts is more disturbing, however. Our simula-
tion exercises suggest that potentially 80 percent to 100 percent of the pro¢ts to
strategies based on this methodology can be explained by our prior familiarity
with the data. The increase in the snooping bias is quite dramatic, as the two-
way sorts are increased from the 3 3 to 10 10 portfolios, all of which have been
used in the literature.The trend toward simultaneous sorting of ¢rms on multiple
characteristics is understandable given the lack of support for a single-factor
model. Our evidence suggests, however, that caution needs to be exercised in in-
terpreting the predictive relations uncovered by such studies.The higher propen-
sity for data snooping when a researcher moves from one-way to two-way (or even
a three-way) sorts exists because it is much easier to generate a larger number of
portfolios while simultaneously conditioning on multiple characteristics. We
show that this tendency is exacerbated because multisort strategies that gener-
ate the highest pro¢ts are also ones that sort based on correlated ¢rm character-
istics.
We also evaluate the performance of typical out-of-sample tests used in empiri-
cal studies. Many out-of-sample tests amount to subperiod analyses because the
entire data set is ¢rst used to show the in-sample e¡ectiveness of particular ¢rm
characteristics, and then the same data is split up into smaller sets to conduct
the‘‘out-of-sample’’ tests.We ¢nd that the out-of-sample pro¢tability of the trading
strategies declines substantially; the remaining pro¢ts are statistically insignif-
icant.
Another pattern in studies attempting to con¢rm the existing evidence ‘‘out-of-
sample’’ is to append a signi¢cantly shorter time series of data to the original
data, and to use the resulting longer time series to con¢rm the initial evidence.
Virtually all studies that document the size e¡ect, for example, fall into this ca-
tegory. This ‘‘out-of-sample’’experiment is also likely to be a¡ected by any snoop-
ing bias that is present in the original results.To gauge the extent of such bias, we
conduct a battery of tests that measure the rates of decay in the out-of-sample
predictability of both the ‘‘real’’and ‘‘simulated’’ ¢rm characteristics. On average,
the two decay rates are similar, again suggesting that snooping biases may have a
nontrivial impact on our collective ¢ndings on the relations between equity re-
turns and ¢rm characteristics.
Section I explains the methodology used in the paper. Section II describes the
data and presents the detailed evidence. Section III presents out-of-sample tests,
and Section IVcontains a brief summary and conclusion.
I. Methodology
Table AI of the Appendix lists the 15 commonly (and successfully) used value
versus glamour ¢rm characteristics, while Table AII contains a description of the
COMPUSTATand CRSP variables used to construct the characteristics. For both
the in- and out-of-sample strategies, we use these ¢rm characteristics to examine
two types of trading rules popular in the literature: one-way and two-way sorts.
For one-way sorts, we form 5 ^50 portfolios. For two-way sorts, we independently
sort ¢rms into 3^10 groups for each variable, resulting in a total of 9^100 portfolios.
We compute the average cross-sectional di¡erences in returns based on the
predictive variables and methods that are commonly used in the literature. First,
we assume that the investor sorts ¢rms into portfolios each year based on values
of the lagged predictive variables. Stocks in each portfolio are equally weighted,
and the monthly returns of the portfolios are calculated from July to June of the
following year. For the one-way sorts, the investor next examines the mean re-
turns (calculated over the entire sample) of all the ranked portfolios at the end
of the sample period. She then calculates the ‘‘strategy return’’ to the combined
zero-cost portfolio that is long (short) in the extreme-ranked portfolios (e.g., 10 or
1 for the 10 -portfolio one-way sort) for a particular predictive variable. This pro-
cedure is followed for each of the ¢rm characteristics, giving an average return
for the long, short, and combined portfolio for each of the sort combinations.
To choose among two-way-sort strategies, we ¢rst form 9 (through 100) portfo-
lios by sorting ¢rms independently into 3 (through 10) groups based on the lagged
values of both the ¢rm characteristics under consideration. Average monthly re-
turns from July to June of the following year are calculated for each of the port-
folios. As before, the investor selects the extreme portfolios based on the two-way
sorts (e.g., 1 or 9 for the 3 3 two-way sort) and forms a zero-cost portfolio by buy-
ing one extreme portfolio using the proceeds from shorting the other extreme
portfolio.This procedure is followed for each of the two-way sorts, giving an aver-
age return for the long, short, and combined portfolios.4
We assume that the investor uses the entire sample period to examine the rela-
tion between predictor variables, or combinations thereof, at time t, and returns
at time t þ 1. This technique is similar to both academic studies that analyze the
predictive ability of ¢rm characteristics and ‘‘back testing’’ used by ¢nancial in-
stitutions to analyze the e¡ectiveness of proprietary trading strategies.
This procedure, however, has two potential sources of data-snooping bias. The
¢rst and more obvious source of bias is that all 15 ¢rm characteristics in our sam-
ple successfully capture cross-sectional di¡erences in the in-sample returns of va-
lue versus glamour stocks. It is therefore possible that we discovered these
4
We omit four combinations of variables, one for each of the cases where a time-series vari-
able is matched with its own cross section.
variables after systematic searches over a wide range of potential variables over
the past several decades. We attempt to provide the reader with a sense of the
number of searches needed over randomly generated ¢rm characteristics to cre-
ate an illusion of predictability similar to the one documented in the literature.
The second source of snooping is subtler and directly related to the sorting
procedures common to the asset pricing literature. It is assumed in most studies
that each researcher ex ante determines both (a) the number of portfolios to sort
securities into, and (b) the strategy to trade only the extreme portfolios based on
the ex ante rankings of the ¢rm characteristic involved. These choices may also
su¡er from snooping since prior familiarity with the ¢rm characteristic is bound
to unwittingly in£uence them.5
We create four measures to capture the biases from these potential sources of
snooping. Each measure involves calculation of pro¢ts that are generated in data
sets that, by design, have no predictability. To generate the random samples, we
¢rst generate random ‘‘¢rm characteristics.’’ For each of the one-way simulations
we use a nonrepeating seed to generate a random factor BN (0, 1), while for the
two-way simulations, again using nonrepeating seeds, we generate two random
factors BN (0, 1). The random ¢rm characteristics have no time-series or cross-
sectional relations with the ¢rms’ returns and, therefore, by design cannot be ex
ante predictors of returns.6
All four data-snooping measures then use the random ¢rm characteristics to
answer the following question: What proportion of the real pro¢ts observed in
the data (and reported in the literature) can be generated by implementing trad-
ing strategies based on one- and two-way sorts of the 15 ‘‘best’’ random variables
selected from a pool of N potential characteristics? The number of random char-
acteristics, N, over which the search is conducted is varied between 200 and
5,000. The main di¡erences between the four measures hinge on the de¢nition of
the term ‘‘best,’’ which re£ects ex ante constraints the researcher or investor im-
poses on the strategies. The fewer constraints imposed, the greater the potential
for data snooping. To capture the £exibility available to the researcher regarding
the ad hoc choice of the number of portfolios into which the sample of securities
is sorted, we choose between 5 and 50 portfolios for the one-way sort and between
9 and 100 portfolios for the two-way sort (resulting from 3 3 through 10 10 two-
way analyses).
The ¢rst measure, ‘‘Nomono,’’ is the most aggressive measure of snooping,
where the pro¢ts to the trading strategy portfolio are calculated as the di¡erence
in returns to the ex post highest versus lowest performing portfolios. Contrary to
5
It is quite common to observe di¡erent sorting choices by di¡erent researchers. The num-
ber of portfolios that ¢rms are sorted into typically range between 5 and 10 (see any study
based on size or book-to-market sorts) using one-way sorts, to as many as 100 portfolios based
on two-way sorts (see, e.g., the seminal paper by Fama and French (1992), and also Banz (1981),
Basu (1983), Lakonishok et al. (1994), Fama and French (1995), Daniel and Titman (1997), and
numerous others).
6
For our sorts, we require all returns in our sample to have nonmissing values of the sort-
ing variables in the Appendix. We do this to ensure that the unconditional return distribu-
tions of the real and random sorts are identical.
the apparent practice used in the literature,‘‘Nomono’’ implies that there is no ex

ante monotonicity in the ranking requirements for the traded portfolios.
Although this is an aggressive measure of snooping, given the numerous studies
(published and unpublished, academic and practitioner) that have attempted to
uncover predictive relations in returns data, it is plausible that we collectively
have searched for the best (say 15) ¢rm characteristics that also happen to have
a monotonic relation with returns.7
The second measure of data-snooping,‘‘Weakmono,’’ is based on the two trading
portfolios at each of the extremes of the monotonic ranking of the ¢rm character-
istic(s), but allows the researcher the £exibility to choose among them. For exam-
ple, in a 10 -portfolio one-way sort, the researcher can choose to trade portfolios 1
or 2 and 9 or 10, whichever yields the highest (lowest) returns and therefore max-
imizes the returns to the zero-cost portfolio. Such choices may re£ect concerns
about the reliability of data in the extreme portfolios, or judgments regarding
nonlinearities in the data (e.g., those related to negative earnings). For examples
of such patterns in published work, see Tinic and West (1986), Fama and French
(1992), Brennan, Jegadeesh and Swaminathan (1993), Lakonishok, Shleifer, and
Vishny (1994), and Daniel and Titman (1997).
The third measure, ‘‘Mono,’’ maintains the ex ante monotonicity apparently
used in the literature. Hence, in a 10 -portfolio one-way sort, the trader can only
be short (or long) in portfolios 1 or 10, where the ranking is determined ex ante.
One could, of course, argue that in practice traders (or researchers) also ex ante
stipulate which extreme portfolio (10 or 1) is bought or sold, and that our measure
therefore e¡ectively allows for snooping on the extreme portfolios. Such a require-
ment would be most likely if the variables examined have theoretical justi¢cation.
In the absence of rigorous guidelines for the choice of variables, however, we do not
stipulate whether extreme portfolios should represent long or short positions.
Our fourth measure attempts to capture our familiarity with the data that is
inherent in the pretesting mentioned above. The measure,‘‘Signi¢cant beta,’’ cal-
culates the pro¢ts to the trading strategy as the di¡erence in returns to portfolios
based on the sorting of a ¢rm characteristic that was found to have signi¢cant
cross-sectional beta (jt-statisticj 4 1.96) in a prior regression of returns on the
same characteristic. As in the Nomono measure, the ‘‘strategy return’’ is calcu-
lated as the di¡erence in returns between the high and low portfolios based on
ex post performance.
Our methodology for evaluating the impact of data snooping on the pro¢ts of
strategies based on ¢rm characteristics of common stocks has some key advan-
tages. First, in comparing in-sample strategy returns in the real and random
data, we generate measures of snooping whose economic signi¢cance is easily
evaluated since they are also measured in pro¢ts or returns. This is of particular
interest in assessing the pro¢tability of extant cross-sectional trading strategies
where R-squared measures are less frequently used. Second, a practical advan-
7
Virtually every study indulges in some unavoidable data snoopingFcertainly the authors
of this study have (pro¢tably) conducted analyses on portfolios sorted by size and price, for
example.
tage of our methodology is that we employ a portfolio formation technique that is

directly comparable to the methods used in most of the recent predictability lit-
erature (namely, cross-sectional sorts).We do not develop our own in-sample pre-
dictors based on complex patterns detected with a‘‘black box’’ technology, such as
a sophisticated data-mining tool like a genetic algorithm or other forms of arti¢-
cial intelligence.We instead employ the historical distributions of variables that
have been purported to have meaningful economic links with expected returns.
Finally, our bootstrapping methodology can be adapted to di¡erent contexts to
gauge the e¡ects of snooping.
II. The Evidence

A. Data
We construct a sample of non¢nancial ¢rms that have returns listed in the 1995
CRSP monthly ¢les and data in the COMPUSTAT annual industrial ¢les from
1955 through 1995. Our sample includes ¢rms that are listed on the NYSE,
AMEX, and Nasdaq exchanges. To minimize the back¢ll bias (see, e.g., Chan et
al. (1995)), we require that ¢rms have a minimum of two years of data available on
COMPUSTAT before they are included in the sample. We compute the values of
each of the 15 ¢rm characteristics used in this study (see the Appendix) for each
company, including (the logs of) earnings^price (E/P), dividend^price (D/P), cash
£ow^price (C/P), and book-to-market (B/M) ratios, as well as price, market capi-
talization (size), and prior return measures. Following Breen and Korajczyk
(1995), we include four time-series variables in the sample; speci¢cally, time-ser-
ies versions of B/M, D/P, past 12-month returns, and price per share.
In the construction of all the ¢rm characteristics, we do not use any informa-
tion that would be unavailable to the investor at the time the portfolio decisions
are made.We therefore match COMPUSTAT ¢scal year-end data from year t 1
with CRSP returns measured from July of year t to June of year t þ 1 (see, e.g.,
Fama and French (1992)). Price and market capitalization are calculated in June
for the end of year t. Lagged 1- and 3 -year returns are calculated from the begin-
ning of July of year t j, where j ¼ 1, 3, to the end of June of year t. Returns are
calculated only when securities are traded, which should mitigate any e¡ects of
nontrading in the sample. If a ¢rm is delisted during the year, we substitute the
T-bill return for its equity return for the remainder of the year.
B. In-sample Pro¢ts: One-way Sorts

Table I presents the distribution of in-sample pro¢ts to the long, short, and
combined (zero-cost) portfolios using one-way sorts. Panels A^D contain esti-
mates for the 5 ^50 -portfolio sorts. The average (across the characteristics or
‘‘strategies’’) pro¢ts for the combined (zero-cost) portfolio for the 5 -portfolio sort
are 0.42 percent per month and statistically signi¢cant with a t-statistic of 2.39.
Not surprisingly, the average pro¢ts increase as the number of portfolios in-
creases, and amount to 0.76 percent per month for the 50 -portfolio strategy in
Panel D. The pro¢ts of zero-cost (or combined) portfolios can obviously be scaled
Table I
In-sample Pro¢ts to Trading Strategies Based on One-way Sorts of Real
Data, 1965 ^1995
This table contains in-sample pro¢ts of trading strategies that are based on one-way sorts of 15
¢rm characteristics, 11 cross-sectional and 4 time-series. Securities are ranked into 5 (Panel A)
through 50 (Panel D) categories using each of the characteristics and then combined into port-
folios. Portfolio L (S) denotes an extreme portfolio (e.g., 5 or 1, or 50 or 1, in Panels A and D,
respectively) based on the ex ante sorting of each of the ¢rm characteristics. The mean return
of L (S) is the average return across all ¢rm characteristics.The combined zero-cost portfolio, C,
is long in L and short in S. Mean pro¢ts and returns are in percent, with corresponding t-sta-
tistics and the standard deviation of the returns and pro¢ts in the adjacent columns, and ‘‘Min’’
and ‘‘Max’’are the highest and lowest average returns (pro¢ts) across individual ¢rm character-
istics over the 30 -year (1965:07^1995:06) sample period.
Portfolio Mean T-Stat. Std Min Max
Panel A: 5 -Portfolio Sort
L 1.32 4.55 0.17 1.06 1.60

S 0.89 3.02 0.13 0.70 1.08
C 0.42 2.39 0.25 0.10 0.89
Panel B: 10 -Portfolio Sort
L 1.37 4.30 0.20 0.99 1.63

S 0.84 2.75 0.13 0.64 1.04
C 0.52 2.41 0.28 0.19 0.98
Panel C: 30 -Portfolio Sort
L 1.48 3.91 0.33 0.93 2.10

S 0.80 2.54 0.18 0.46 1.01
C 0.65 2.26 0.43 0.14 1.60
Panel D: 50 -Portfolio Sort
L 1.53 3.73 0.43 0.94 2.48

S 0.74 2.30 0.20 0.33 1.00
C 0.76 2.16 0.52 0.00 2.07
to any size. However, a comparison of the magnitude of these pro¢ts with the
returns to the long and short portfolio strategies (e.g., 1.32 percent per month
and 0.89 percent per month for the 5 -portfolio and 1.53 percent and 0.74 percent
for the 50 -portfolio strategies, respectively) shows that they are economically sig-
ni¢cant as well.The annualized returns to the trading strategies range between 5
percent and 9 percent for the 5 ^50 -portfolio strategies.
For brevity, we do not report the performance of strategies based on each of the
¢rm characteristics, but the strategies that perform the best are based on ¢rm
characteristics that are most commonly reported in the literature. For example,
for the 10 -portfolio sort, the strategies producing the maximum pro¢ts are book-
to-market and cash-£ow-related variables.This pattern is consistent with two dia-
metrically opposed possibilities: (a) commonly used variables in the literature
are indeed ‘‘truly’’ related to the cross section of expected returns, or (b) these
variables have emerged as ‘‘winners’’ following our collective mining of the data.
Our paper is an attempt to determine the relative importance of these two hy-
potheses.
Figure 1, Panels A^D, presents simulation evidence on all four snooping mea-
sures that correspond directly to the real pro¢tability of the trading strategies
reported in Table I. Recall that the measures use random ¢rm characteristics to
answer the following question: What proportion of the real pro¢ts observed in
the data can be generated by implementing trading strategies based on one-way
sorts of the 15 ‘‘best’’ random variables searched from a pool of N potential char-
acteristics, where N is varied between 200 and 5,000? The y-axis of Figure 1 shows
average pro¢ts to the combined portfolios of the ‘‘best’’ 15 random factors as a
percentage of the real average pro¢ts to the combined portfolios reported in
Table I.The x-axis measures the number of searches that are conducted to obtain
these 15 characteristics, and is scaled in increments of 200 up to 5,000.
If, for example, the reader believes that the entire profession conducted 200 in-
dependent searches to distill the 15 ‘‘real’’ ¢rm characteristics, Panel A suggests
that data snooping could explain between 22 percent and 37 percent of the pro¢ts
obtained in the 5 -portfolio one-way sort.These proportions increase to 39 percent
to 47 percent for 5,000 searches. The variation in the estimates (between 22 per-
cent and 37 percent or between 39 percent and 47 percent) depends on the snoop-
ing measure used: ‘‘Weakmono,’’ ‘‘Mono,’’ ‘‘Signi¢cant_beta,’’ or ‘‘Nomono.’’8 This
particular ¢nding can of course be interpreted in several ways, but one particu-
lar interpretation is quite powerful. One can conclude that 200 researchers had
to simultaneously conduct only one search each to uncover 15 ¢rm characteris-
tics that could generate ‘‘pro¢ts’’ on the order of 22 percent to 37 percent of the
real pro¢ts reported in one-way ¢ve-portfolio studies, even though the character-
istics have no real predictive ability. Not surprisingly, the proportions in Figure 1
increase for all four measures with an increase in the number of searches.
There are two other noteworthy aspects of the evidence in Figure 1. First, the
simulated pro¢ts grow at a higher rate than the real pro¢ts as the number of port-
folios that the securities are sorted into increases (see Table I).This suggests that
snooping e¡ects increase with the ¢neness of the sort. Second, for each sorting
procedure, the fraction of the pro¢ts explained increases fairly sharply for smal-
ler values of N, and then stabilizes at proportions less than 100 percent of the
pro¢ts observed in the real data. This suggests that data snooping can explain
some, but not all, of the predictability reported in the literature.
Most of the published analyses on one-way strategies use 10 -portfolio sorts,
making Figure 1, Panel B, the most relevant one for us to consider. For this spe-
ci¢c type of strategy, the proportion of real pro¢ts that can be generated by ran-
dom factors ranges between 30 percent and 50 percent for the 200 iteration case,
and between 47 percent and 68 percent for the 5,000 iteration case. This suggests
that although a substantial fraction of the reported predictability may be spur-
8
Note that most of this increase occurs by about 1,200 searches, with the estimates ran-
ging between 33 and 43 percent. After this point, there is minimal ‘‘advantage’’ from more
familiarity with the data.
(A) (B)
(C) (D)
Figure 1. Pro¢ts to one-way trading strategies implemented on randomized re-

turns. The x-axis is the number of runs generating a random N (0,1) predictive variable.
The increments are in 200 runs, ranging from 200 up to 5,000 runs. Panels A^D of the
graph show the percentage of pro¢ts (i.e., 0.60 ¼ 60 percent) obtained for the average of
the combined portfolios for the ‘‘best’’ 15 random factors as a percentage of the average
combined real pro¢ts found in the 5 -, 10 -, 30 - and 50 -portfolio one-way trading strategies
reported in Table I. For the random data portfolios,‘‘best’’ is de¢ned in terms of four unique
measures: ‘‘Nomono’’pro¢ts are calculated as the di¡erence in returns to the high and low
portfolios where these portfolios are chosen based on ex post performance, so that they
could be any portfolio of the ¢rm characteristic sort; ‘‘Weakmono’’ pro¢ts are calculated
as the di¡erence in returns to the high and low portfolios where these portfolios are cho-
sen, for example, for the 10 -way sorts if they belong to deciles (1, 2) or (9, 10) of the ¢rm
characteristic; ‘‘Mono’’ pro¢ts are calculated as the di¡erence in returns to the high and
low portfolios where these portfolios are chosen if they belong to deciles 1 or 10 of the ¢rm
characteristic; and ‘‘Signi¢cant_beta’’ pro¢ts are calculated as the di¡erence in returns to
the high and low portfolios where these portfolios are chosen if the underlying ¢rm char-
acteristic was found to have signi¢cant cross-sectional beta (t-statistic 4 1.96) in a prior
regression of returns on the characteristic. For the Signi¢cant_beta category, pro¢ts are
calculated as the di¡erence in returns to the high and low portfolios where these portfo-
lios are chosen based on ex post performance, so that they could be any deciles of the ¢rm
characteristic.
ious, it is reassuring that a large fraction of the pro¢ts appear to be ‘‘real.’’

This conclusion is of course subject to the caveat that the pro¢ts have not
been adjusted for transactions costs or risks involved in the execution of the
strategies.
C. In-sample Pro¢ts: Two-way Sorts

The evidence for the trading strategies based on two-way sorts is shown in Table
II, with Panels A^D containing average pro¢ts for the long, short, and combined
portfolios for the 3 3 through 10 10 sorts. The average pro¢ts to the combined
portfolios are again positive and statistically signi¢cant at 0.57 percent per month
for the 3 3 sort. This amounts to an annualized return of seven percent. Again,
there is a systematic and substantial increase in the pro¢tability of the trading stra-
tegies from the 3 3 sort to the 10 10 sort, with returns to the latter being 1.02
percent per month (or, equivalently, over 12 percent on an annualized basis).9
The ¢ndings in Table II are consistent with the evidence reported in the litera-
ture in two important respects. First, using relatively na|«ve ‘‘trading rules’’ that
exploit the information contained in publicly available ¢rm characteristics, we
can apparently earn statistically and economically signi¢cant pro¢ts on zero-
cost portfolios. Second, ¢rm characteristics that exhibit the highest degree of
predictive ability are also ones that have captured the attention of the profession,
such as market capitalization (Keim (1983)), book-to-market (Fama and French
(1992)), and cash £ow-to-price ratios (Lakonishok et al. (1994)).
The results from the simulation exercises for the 3 3 through 10 10 two-way
sorts are presented in Figure 2, Panels A^D, which correspond to the real strate-
gies presented for the two-way sorts in Table II, Panels A^D. The simulations for
the two-way sorts are di¡erent in that 101 two-way combinations are chosen as
the ‘‘best’’ among the N pairs considered in the simulation.10 For the N ¼ 200 si-
mulation exercise presented in Panel A, the proportion of pro¢ts explained by the
snooping measures ranges between 29 percent and 34 percent of the 0.57 percent
per month pro¢ts in the real data.This percentage increases steadily as the num-
ber of ¢rm characteristics considered increases, with the estimates ranging be-
tween 39 percent and 45 percent for N ¼ 5,000. The striking aspect of Figure 2,
however, is the dramatic increase in the snooping bias as the number of portfolios
in the two-way sorts increases. Even for the case of N ¼ 200, the proportions
of pro¢ts generated by the simulated strategies vary between 45 percent
and 52 percent for the 5 5 sort, between 58 percent and 70 percent for the 7 7
sort, and between 83 percent and 93 percent for the 10 10 sort. The estimates
approach higher proportions as the number of searches increases to 1,000; for
example, the proportion varies between 80 percent and 100 percent for the
10 10 case.
9
The di¡erences in average pro¢ts across one- and two-way sorts (compare Tables I and II)
are not large, and the variation in pro¢ts across strategies is smaller for two-way relative to
one-way sorts. This suggests that two-way combinations of the characteristics do not provide
substantially more information about cross-sectional di¡erences in returns than the one-way
sorts. This may be due to the fact that the ¢rm characteristics are correlated. While the aver-
age correlation is only 0.126, the correlations in the tails of the distribution are large, 0.779
and 0.349.
10
Pairwise combinations of the 15 real variables generate the 105 two-way combinations:
(15 * (15 1))/2 pairwise combinations, less the four combinations where we sort on both
the time-series and the cross-sectional counterparts of the same characteristic (because these
sorts have virtually no observations).
Table II
In-sample Pro¢ts to Trading Strategies Based on Two-way Sorts of Real
Data, 1965 ^1995
This table contains the pro¢ts of trading strategies that are based on two-way independent
sorts of 15 ¢rm characteristics, 11 cross-sectional and 4 time-series. We examine all two-way
combinations of the 15 variables except for two-way combinations that use the cross section
and time-series of the same variable. Thus, the results below are reported for 101 (105 4)
two-way combinations. Portfolios are formed by 3 3 (Panel A) through 10 10 (Panel D) sorts
on each pair of the 15 ¢rm characteristics. Portfolio L (S) denotes an extreme portfolio of the 9
(or 100) portfolios in the 3 3 (or 10 10) ex ante two-way sorts of pairs of the ¢rm character-
istics. The mean return of L (S) is the average return across all ¢rm characteristics. The com-
bined zero-cost portfolio, C, is long in L and short in S. Mean pro¢ts and returns are in percent,
with corresponding t-statistics and the standard deviation of the returns and pro¢ts in the ad-
jacent columns, and ‘‘Min’’and ‘‘Max’’are the highest and lowest average returns (pro¢ts) across
individual ¢rm characteristics over the 30 -year (1965:07^1995:06) sample period.
Panel A: 3 3 Sort
L 1.39 4.47 0.13 1.15 1.79

S 0.79 2.71 0.12 0.47 1.00
C 0.57 3.12 0.17 0.26 1.06
Panel B: 5 5 Sort
L 1.48 4.15 0.21 1.10 2.23

S 0.68 2.22 0.18 0.05 0.98
C 0.76 2.69 0.30 0.24 1.57
Panel C: 7 7 Sort
L 1.47 3.77 0.23 1.06 2.12

S 0.57 1.77 0.27 0.71 0.98
C 0.84 2.40 0.35 0.04 2.07
Panel D: 10 10 Sort
L 1.53 3.50 0.24 0.92 2.23

S 0.46 1.27 0.33 0.62 0.95
C 1.02 2.24 0.42 0.11 2.07
Given that up to 10 10 two-way sorts have been used in the literature, the
estimates in Figure 2 are disturbing. Large proportions of the reported pro¢ts
(or predictability) in the literature could be a result of our prior familiarity with
the data. Ironically, in the absence of theory-based identi¢cation of the
speci¢c multiple asset pricing factors, two-way sorts also seem to be the more
legitimate and sensible course for empiricists to pursue. But, unlike the one-
way sorts where a reasonable case can be made for genuine predictability in the
data based on value versus glamour characteristics, our simulation evidence sug-
gests that conclusions based on two-way sorts need to be interpreted with far
more caution.
(A) (B)
(C) (D)
Figure 2. Pro¢ts to two-way trading strategies implemented on randomized re-

turns. The x-axis is the number of runs generating a random N (0,1) predictive variable.
The increments are in 200 runs, ranging from 200 up to 5,000 runs. Panels A^D of the
graph shows the percentage of pro¢ts obtained for the average of the combined portfolios
for the ‘‘best’’ 15 random factors (or the 101 two-way combinations thereof) as a percentage
of the average combined real pro¢ts found in the 3 3 to 10 10 two-way trading strategies
reported in Table II. For the random data portfolios,‘‘best’’ is de¢ned in terms of four un-
ique measures: ‘‘Nomono’’pro¢ts are calculated as the di¡erence in returns to the high and
low portfolios where these portfolios are chosen based on ex post performance, so that
they could be any portfolio of the ¢rm characteristic sort; ‘‘Weakmono’’ pro¢ts, not re-
ported for the 3 3 sorts, are calculated as the di¡erence in returns to the high and low
portfolios where these portfolios are chosen if they belong to an extreme corner portfolio,
or the portfolio adjacent to an extreme corner portfolio; ‘‘Mono’’ pro¢ts are calculated as
the di¡erence in returns to the high and low portfolios where these portfolios are chosen if
they belong to an extreme corner portfolio; and ‘‘Signi¢cant_beta’’ pro¢ts are calculated as
the di¡erence in returns to the high and low portfolios where these portfolios are chosen if
the underlying ¢rm characteristic was found to have signi¢cant cross-sectional beta (t-
statistic 4 1.96) in a prior regression of returns on the characteristic. For the Signi¢cant_-
beta category, pro¢ts are calculated as the di¡erence in returns to the high and low port-
folios where these portfolios are chosen based on ex post performance, so that they could
be any portfolio of the ¢rm characteristic. At the lower number of runs and higher number
of portfolios, 101 combinations do not always meet the de¢nitions of ‘‘best.’’ For example, for
the 10 10 sorts and the ‘‘Weakmono’’classi¢cation, we ¢nd 5 signi¢cant cases at 200 runs,
24 cases at 1,000 runs, 52 cases at 200 runs, and 101 cases at 4,000 and above. For ‘‘Mono,’’ we
¢nd 1 case at 200 runs, 4 cases at 1,000 runs, and 12 cases 4,000 runs and above. For signi¢-
cant beta, we ¢nd 19 cases at 200 runs, 94 cases at 1,000 runs, and 101 cases at 1,200 runs
and above.
Why do two-way sorts have a greater potential for data-snooping bias? This
propensity comes from two sources. First, it is simply easier for a researcher to
generate a larger number of portfolios using two-way sorts. Speci¢cally, a re-
searcher who views a ¢ve-way sort as the minimum number of groups required
to generate adequate cross-sectional dispersion in the characteristic of interest
would quite naturally examine a minimum of 25 portfolios if two factors are con-
sidered. This seemingly innocuous practice will lead to a larger propensity to in-
advertently snoop the data.We examine the magnitude of this bias by estimating
the relation between average pro¢ts and the number of groups or portfolios used
to categorize the securities. In both the real and simulated data, we regress the
average pro¢ts across all characteristics in one-way and two-way sorts on the
number of portfolio groupings employed (P). These regressions are shown in
Table III. In all cases, the number of groupings/portfolios is strongly and posi-
tively related to the level of pro¢ts. For example, the coe⁄cient on P in the two-
way real data of 0.0045 implies an increase in predicted pro¢t of approximately
seven basis points per month that can be achieved by merely moving from a 10 -
portfolio one-way sort to a 5 5 -portfolio two-way sort.
The second source of pro¢ts to the two-way strategies is related to the nature of
the variables that researchers typically use. As mentioned earlier, the average
correlation between the 15 ¢rm characteristics in the sample is 0.13, but the cor-
relation among the ‘‘successful’’ variables (those that are in the top decile of the
two-way trading strategies’ pro¢ts) more than doubles to 0.32. Consequently, we
reestimate the relation in two-way sorts between average pro¢ts and the number
of portfolios for tercile correlation subgroups.The results are presented in Panel
B of Table III.
Note that the coe⁄cient on P, the number of portfolio groupings employed, dou-
bles in the real data for highly correlated characteristics.Therefore, a move from
a 10 -portfolio one-way sort to a 5 5 -portfolio two-way sort would lead to an in-
crease in average monthly pro¢ts of 10 basis points, or a 15 percent increase from
the benchmark. The intuition for this is straightforwardFthe increase in the
number of portfolios when the two characteristics are more strongly related is
roughly equivalent to a ¢ner sort on a single characteristic. More interestingly,
the coe⁄cient of P for the highly correlated characteristics in the real data is
strikingly similar to the coe⁄cient of P in the two-way sorts for highly correlated
characteristics in the simulated data (0.0068 vs. 0.0076). This evidence suggests
that, apart from being simply a ¢ner cut on a (single) real factor, two-way sorts
may have a greater tendency to generate spurious pro¢ts. We investigate this is-
sue in the section below, when we examine the decay rates of pro¢ts in the real
and simulated data for one- and two-way sorts.
III. Out-of-sample Evidence

A common practice in the ¢nance literature is to use ‘‘out-of-sample’’ tests
to gauge the robustness of the predictive relations established within a given
sample. In this section, we present traditional and some new out-of-sample tests
Table III
Regressions of Combined Portfolio Pro¢ts on the Number of Portfolios
in a Sort
This table contains OLS regressions of combined portfolio pro¢ts on an intercept and the num-
ber of portfolios in a sort. For one-way sorts, we use the combined portfolio pro¢ts from 10, 25, 50,
and 100 sorts. For two-way sorts, we use the combined pro¢ts from 3 3, 5 5, 7 7, and 10 10
sorts. In Panel A, we report regression results for real-data one-way sorts, real-data two-ways
sorts, random-data one-way sorts, and random-data two-way sorts. In Panel B, we report regres-
sion results for two-way sorts for both real and random data using subgroups based on tercile
groupings of correlations between the ¢rm characteristics employed in the sorts. For the ran-
dom sorts, we carry out the analysis using the best 101 two-way random variable combinations
chosen from the 5,000 simulations. We restrict the combined portfolios to be formed using only
the extreme portfolios, thus imposing monotonicity. We multiply all point estimates by 100.
T-statistics are in parentheses.
Real Data Simulated Data
Panel A: One-way and Two-way Regressions
One-way sorts Coe⁄cient on the number 0.0034 (2.01) 0.0075 (10.73)

of portfolios in sort (P)
Two-way sorts Coe⁄cient on the number 0.0045 (9.49) 0.0067 (30.43)
of portfolios in sort (P)
Panel B: Two-way Regressions by Levels of Correlation between the Firm Characteristics of the
Sorts
Low correlation tercile Coe⁄cient on the number 0.0033 (4.80) 0.0053 (17.05)
two-way sorts of portfolios in sort (P)
Middle correlation Coe⁄cient on the number 0.0035 (4.70) 0.0077 (21.98)
tercile two-way sorts of portfolios in sort (P)
High correlation tercile Coe⁄cient on the number 0.0068 (7.65) 0.0077 (20.88)
two-way sorts of portfolios in sort (P)
to gauge the robustness of our conclusions based on the in-sample simulation ex-
ercises.
In the traditional out-of-sample tests, we construct our trading strategies by
again ranking securities into portfolios based on ¢rm characteristics or combina-
tions thereof. As before, we require that the strategies consist only of extreme port-
folios, for example, portfolios 1 or 10 in a one-way 10-portfolio sort, or any corner
combination in a two-way sort. Next, we identify portfolios formed at time t that
earn the largest and smallest returns in year t þ 1 over a given ¢ve-year in-sample
period. Last, we use these same portfolios (or ‘‘rules’’) in an adjacent future ¢ve-
year ‘‘out-of-sample’’ period, with the investor purchasing (shorting) the portfolio
that had the highest (lowest) returns in the prior in-sample subperiod.We roll for-
ward through the data, estimating optimal in-sample rules that are then used as
the basis for strategies for subsequent out-of-sample periods. This process results
in a nonoverlapping time series of long, short, and combined out-of-sample portfo-
lio returns to each of the one- and two-way variable combinations.
The out-of-sample results for both the one- and two-way sorts are reported in
Table IV. For brevity, we restrict our one-way sorts to the 10 - and 50 -portfolio
cases and the two-way sorts to the 3 3 - and 7 7-portfolio cases. Not surpris-
ingly, the out-of-sample predictive ability of the 15 real ¢rm characteristics weak-
ens. Table IV, Panels A and B, show that out-of-sample pro¢ts to the zero-cost
combined portfolio using one-way sorts decline by 50 percent (from 0.52 percent
to 0.26 percent per month) for the 10 -portfolio case and by 55 percent (from 0.76
percent to 0.34 percent per month) for the 50 -portfolio case. The di¡erences be-
tween the in- and out-of-sample pro¢ts are statistically signi¢cant with p-values
of less than 0.001. The results for the two-way sorts in Panels C and D show even
larger percentage drops in the pro¢tability of the trading strategies, with the out-
of-sample pro¢ts dropping by 58 percent for both the 3 3 and 7 7 sorts. None of
the trading strategies’ pro¢ts reported in Table IV are statistically signi¢cant,
with the highest t-statistic being 1.39. In addition, Spearman correlation analysis
of the rank ordering of in- versus out-of-sample pro¢ts of trading strategies shows
that, on average, a strategy’s in-sample pro¢tability is not a good predictor of its
relative out-of-sample performance.
In spite of the statistically weak pro¢tability of the strategies reported in Table
IV, the pro¢ts remain economically signi¢cant; out-of-sample annualized returns
are three to four percent for one-way sorts and about seven percent for two-way
sorts. However, snooping is likely to a¡ect even these out-of-sample estimates.
Speci¢cally, we have assumed that the 15 ¢rm characteristics used in the trading
strategies are chosen randomly. Previous studies and our results in Tables I and
II, however, have already shown that these ¢rm characteristics are correlated
with returns over the entire sample period. The ‘‘out-of-sample’’ pro¢ts reported
in Table IVare therefore not strictly out-of-sample; they are based on subperiods
that are part of the overall sample used in the literature to generate the in-sample
pro¢ts.11
To address the above concern that typical out-of-sample tests may not be truly
out-of-sample, we examine another variant of such tests: the use of a single hold-
out period (see, e.g., Davis, Fama, and French (2000)). We divide our sample into
two equal subperiods. Using random ¢rm characteristics in one-way simulations,
we ¢nd 207 strategies out of 5,000 that have signi¢cant betas at the ¢ve percent
level or better in the ¢rst subperiod.When we test these 207 strategies in the sec-
ond ‘‘holdout’’ period, we ¢nd that only 11 have signi¢cant betas of the same sign
at the 10 percent signi¢cance level, and 8 signi¢cant betas at the 5 percent
signi¢cance level. This suggests that if an investigator chooses a successful
strategy at the end of the ¢rst subperiod, and genuinely has no knowledge
of the holdout sample, then it is unlikely that she would reject the null
hypothesis (of no predictabi-lity) in the holdout period by chance (a 11/207 chance
11
Cooper, Gutierrez, and Marcum (2001) further explore such ‘‘real-time’’ issues inherent in
out-of-sample tests by requiring the investor to endogenously determine in-sample the optimal
predictor variables, rules relating those variables to future returns, and the dimensionality of
the sort. Once they endogenize these portfolio investment parameters, it is di⁄cult for an in-
vestor to outperform a passive buy-and-hold benchmark portfolio.
Table IV
Out-of-sample Pro¢ts to Trading Strategies Based on One- and Two-
way Sorts of Real Data, 1965 ^1995
This table contains the out-of-sample pro¢ts of trading strategies that are based on one-way and
two-way sorts of 15 ¢rm characteristics. Panels A and B contain out-of-sample returns and prof-
its of portfolio combinations based on one-way sorts of securities using each of the ¢rm charac-
teristics. Securities are ranked into 10 (Panel A) and 50 (Panel B) categories using each of the
characteristics and then combined into portfolios. Panels C and D contain out-of-sample re-
turns and pro¢ts of portfolio combinations based on two-way sorts of securities using the ¢rm
characteristics. We examine all two-way combinations of the 15 variables except for two-way
combinations that use the cross section and time series of the same variable. Thus, the results
below are reported for 105 4 ¼ 101 two-way combinations. Portfolios are formed by 3 3 (Pa-
nel C) and 7 7 (Panel D) sorts on each pair of the 15 ¢rm characteristics. Portfolio L (S) denotes
an extreme portfolio of the 9 (49) portfolios in the 3 3 (7 7) ex ante two-way sorts of pairs of
the ¢rm characteristics. The mean return of L (S) reported in the table is the average out-of-
sample annual return over the subsequent ¢ve years across all two-way combinations. The com-
bined zero-cost portfolio, C, is long in L and short in S.The L and S portfolios are required to be
a corner portfolio.The investor is assumed to rebalance the portfolios every year after updating
the values of the ¢rm characteristics that form the bases of the strategies. Mean pro¢ts and
returns are in percent, with corresponding t-statistics and the standard deviation of the returns
and pro¢ts in the adjacent columns; and ‘‘Min’’and the ‘‘Max’’are the highest and lowest average
returns (pro¢ts) across individual ¢rm characteristics over the 30 -year (1965:07^1995:06) sam-
ple period.
Panel A: One-way (10 -Portfolio) Sort
L 1.25 4.13 0.18 0.88 1.54

S 0.97 3.49 0.15 0.76 1.24
C 0.26 1.27 0.29 0.12 0.73
Panel B: One-way (50 -Portfolio) Sort
L 1.25 3.49 0.35 0.48 1.87

S 0.87 2.75 0.20 0.40 1.12
C 0.34 1.10 0.55 0.74 1.40
Panel C: Two-way (3 3) Sort
L 1.22 4.37 0.13 0.94 1.50

S 0.93 3.32 0.18 0.55 1.26
C 0.24 1.39 0.18 0.20 0.76
Panel D: Two-way (7 7) Sort
L 1.27 3.59 0.25 0.61 2.04

S 0.79 2.45 0.38 0.21 1.80
C 0.35 1.05 0.38 0.60 1.26
at the 10 percent signi¢cance level, and a 8/207 chance at the 5 percent signi¢-
cance level).
Many ‘‘out-of-sample’’tests however take a di¡erent form than the one discussed
above. Studies attempting to verify the existing evidence out-of-sample use addi-
tional time series of data to con¢rm the evidence initially established over a given
time period. However, the additional time series is typically much shorter in
length compared to the original data, thus causing such experiments to be also
a¡ected by the snooping bias. Virtually all ongoing studies on value versus gla-
mour ¢rm characteristics that use historical CRSP and COMPUSTAT data, for
example, fall into this category. It may therefore be informative to examine the
di¡erence between the initial in-sample, and the shorter out-of-sample, tests.
To formally examine the holdout-period robustness in the real data, we exam-
ine the di¡erences in ‘‘decay rates’’ of the predictability of the real versus the si-
mulated ¢rm characteristics.12 The decay rate is simply a measure of the change
in a speci¢c trading strategy’s pro¢ts following the initial‘‘discovery period.’’ Spe-
ci¢cally, for each of the 15 real ¢rm characteristics and the 15 best random char-
acteristics from the 5,000 simulations, and twoway combinations thereof, we form
trading strategy portfolios starting in 1974 using all past available data.13 We re-
strict the combined portfolios to be formed using only the extreme portfolios,
thus imposing ex ante monotonicity. For each variable, we roll through the data
in yearly increments, and identify the ¢rst occurrence of statistically signi¢cant
pro¢ts (i.e., a return for the combined portfolio with a t-statistic greater than
1.96). For each strategy, we then track the subsequent average pro¢ts, and com-
pute the decay rate as the level of average pro¢ts over a particular period relative
to the average pro¢ts during the discovery period. Thus, a decay rate of 100 per-
cent means that a variable experiences no drop in average pro¢ts after ¢rst dis-
covery, a rate of zero implies that the pro¢ts drop to zero, and a rate of 100
percent means the relationship between the ¢rm characteristic and returns is
completely reversed. For example, if book-to-market has a ¢rst statistically sig-
ni¢cant pro¢t of 0.40 percent in 1978 (using data from the 1965 to 1978), then we
would track the average return going forward in time, and compare it to 0.40 per-
cent. If, for example, over the 1979 to 1989 period the average monthly return hap-
pened to be 0.20 percent for this strategy, then that would imply a decay rate of 50
percent over 10 years.
For a given sort dimension, we stack the decay rates across variables using the
date of ¢rst discovery as the ¢rst observation. We then compute averages across
variables for an ‘‘event window’’ that runs 240 months forward from the date of
¢rst discovery. To draw inferences, we then compare the decay rates in the real
versus simulated data.14 If pro¢ts in the real data decay at a rate greater than or
equal to the simulated data, then the evidence of predictability in the real data is
12
We thank the referee for this suggestion.
13
We start in 1974 to allow for adequate (up to 10 years’ worth) data for all the real ¢rm
characteristics.
14
If a given variable is not signi¢cant until later in the sample, then it will not have obser-
vations for all 240 months.
consistent with snooping. If, on the other hand, the decay rate in the real sample
is lower, then it suggests the existence of some genuine predictability (given the
caveat that our real variable set was determined in the year 2001). Again for brev-
ity, we conduct this analysis for only the 10 - and 50 -portfolio one-way sorts and
the 3 3 - and 7 7-portfolio two-way sorts.
TableVcontains the decay rates in the pro¢ts of both the real and random ¢rm
characteristics. For the real characteristics, the average decay rates range from a
high of almost 60 percent for the 10 -portfolio one-way sort to a low of 20 percent
for the 7 7-portfolio two-way sort. These estimates describe the out-of-sample
pro¢tability of the speci¢c trading strategies considered in this paper. For exam-
ple, for the 10 -portfolio one-way sort, the best variable in terms of decay is book-
to-market, with a decay rate of 146.3 percent (implying that pro¢ts from the use of
this variable actually increase in the out-of-sample period) and the worst perform-
ing variable is price, with a decay of 76.9 percent (implying a reversal in the
relation observed in-sample between this characteristic and equity returns).
A more interesting exercise however is to compare the decay rates in the prof-
its of real trading strategies with the decay rates in the pro¢ts of strategies based
on the 15 best random ¢rm characteristics. The average decay rates across the
four strategies reported in TableVappear to be quite similar. For the 10 -portfolio
one-way and the 7 7-portfolio two-way sorts the decay rates for the real versus
simulated strategies are virtually identical. The test statistics for the di¡erence
between the average decay rates of the pro¢ts of the real versus random charac-
teristics are the statistically insigni¢cant values of 0.01 and 1.30, respectively.
The fact that the decay rates are nonzero in the random samples suggests that the
returns are positively autocorrelated. If stock returns were uncorrelated, there
should be no out-of-sample predictability in the random samples.The nonzero de-
cay rates for the random samples, and their similarity to the ones in the real data,
also suggests that the out-of-sample predictability of the real factors may be a
result of positive autocorrelation in returns, rather than the factors themselves
containing predictive power for future returns.
A comparison of Panels B of Table V shows that pro¢ts of strategies based on
the random data for the 50 -portfolio sort actually exhibit a better decay rate than
those based on real data. The random data portfolio earns 43.7 percent of the in-
itial period pro¢ts, while the real data portfolio earns only 31.7 percent of its cor-
responding discovery period pro¢ts.The t-statistic for the di¡erence between the
average decay rates is 7.72. In fact, the 3 3 sorts in Panels C are the only set of
trading strategies for which the real strategies have a better decay rate than the
strategies based on random ¢rm characteristics. The average decay rates of the
real versus random strategies are 35.1 percent and 27.2 percent, respectively, and
the t-statistic for the di¡erence is 6.11.15
15
Of course, one possibility for why we observe worse decay rates in the real data is that
investors are acting opportunistically to take advantage of any pro¢t opportunities. Our
method of comparing decay rates in real and simulated pro¢ts does not have the £exibility
to distinguish between £eeting, but genuine, pro¢t opportunities and (extreme) draws from
a distribution centered around zero. An alternative approach, based on order statistics, could
potentially be used to make such a distinction.
1988
TableV
Decay Rates for Real and Random Data Sorts
This table contains decay rates for combined portfolio sorts based on real and random ¢rm characteristics. Panels A and B contain decay rates for
one-way 10 - and 50 -portfolio sorts, while panels C and D contain decay rates for 3 3 - and 7 7-portfolio two-way sorts.The decay rate is derived
from the combined portfolio pro¢ts between the ¢rst signi¢cant period for a sort variable and how that variable performs after the initial dis-
covery period. Speci¢cally, for each of the 15 real ¢rm characteristics (or the 101 two-way combinations thereof), we form combined portfolios
starting in 1974 (to allow for an adequate time series of data for each real characteristic), using all past available data. For the random sorts, we
carry out the same analysis on each of the best 15 random variables (or best 101 two-way random variable combinations) chosen from the 5,000
simulations.We restrict the combined portfolios to be formed using only the extreme portfolios, thus imposing monotonicity. For each variable, we
roll through the data in yearly increments using an expanding window, and keep track of the ¢rst occurrence of a signi¢cant combined portfolio
pro¢t (t-statistic greater than 1.96). We then track for each variable what the average pro¢ts are in the years after ¢rst discovery. For each sort
variable, we compute a decay rate equal to the average pro¢ts over a particular period after ¢rst discovery relative to the average pro¢ts during
The Journal of Finance

the discovery period. Thus, a rate of 100 percent means that a variable experiences no drop in average pro¢ts after ¢rst discovery, a rate of zero
implies that the pro¢ts drop to zero, and a rate of 100 percent means the relationship between the ¢rm characteristic and returns is completely
reversed.We line up the decay rates across variables using the date of ¢rst discovery as the ¢rst observation.We then compute the average decay
rate across characteristics for an ‘‘event window’’ that runs 240 months out from date of ¢rst discovery.The ‘‘Mean’’and ‘‘Std’’ (standard deviation)
reported below are from the average monthly decay rate across all characteristics’ decays. The ‘‘Min’’ and the ‘‘Max’’ are the highest and lowest
decay rates per individual ¢rm characteristic.
Real Sorts Random Sorts
Mean Std Min Max Mean Std Min Max
Panel A: One-way (10 -Portfolio) Sort
Decay Rate 59.9% 22.8% 76.9% 146.3% Decay Rate 59.5% 20.6% 21.1% 188.4%
Panel B: One-way (50 -Portfolio) Sort
Panel C: Two-way (3 3) Sort
Panel D: Two-way (7 7) Sort
(A) (B)
(C) (D)
Figure 3. Decay rate event study for real and random data sorts. This ¢gure con-
tains decay rates for combined portfolio sorts based on real and random ¢rm characteris-
tics for one-way 10 - and 50 -portfolio sorts, while Panels C and D contain decay rates for
3 3 - and 7 7-portfolio two-way sorts. The decay rate is derived from the combined port-
folio pro¢ts between the ¢rst signi¢cant period for a sort variable and the performance of
that variable thereafter. Speci¢cally, for each of the 15 real ¢rm characteristics (or the 101
two-way combinations thereof), we form combined portfolios starting in 1974 (to allow for
an adequate time series of data for each real characteristic), using all past available data.
For the random sorts, we carry out the same analysis on each of the best 15 random vari-
ables (or best 101 two-way random variable combinations) chosen from the 5,000 simula-
tions. We restrict the combined portfolios to be formed using only the extreme portfolios,
thus imposing monotonicity. For each variable, we roll through the data in yearly incre-
ments using an expanding window, and keep track of the ¢rst occurrence of a signi¢cant
combined portfolio (t-statistic 4 1.96). We then track for each variable what the average
pro¢ts are in the years after ¢rst discovery. For each sort variable, we compute a decay rate
equal to the average pro¢ts over a particular period after ¢rst discovery relative to the
average pro¢ts during the discovery period. Thus, a rate of 100 percent means that a vari-
able experiences no drop in average pro¢ts after ¢rst discovery, a rate of zero implies that
the pro¢ts drop to zero, and a rate of 100 percent means the relationship between the
¢rm characteristic and returns is completely reversed. We line up the decay rates across
variables using the date of ¢rst discovery as the ¢rst observation. We then compute the
average decay rate across characteristics for an ‘‘event window’’ that runs 240 months out
from date of ¢rst discovery.
Figure 3 plots the average decay rates of the pro¢ts to the real and random
strategies over the 240 months after the initial discovery period. The time-series
behavior of the average decay rates in the graphs, combined with the average es-
timates in Table IV, illustrate a number of important points. First, the behaviors
of the decay rates of the real and random data are similar, both over time and at
any particular point in time. Second, the decay rates are worse for the higher
dimension sorts, which con¢rm our earlier ¢ndings that trading strategies based
on multiple sorts are more likely to yield statistically signi¢cant in-sample pro¢ts
simply due to chance. Third (and something that is not obvious from the graphs),
if we ex post choose the best portfolios (highlighted in the‘‘Max’’columns in Table
IV) from the decay studies, we ¢nd that in three out of four cases (the exception
being the 7 7 sort), strategies based on the best random ¢rm characteristics per-
form better ‘‘out-of-sample’’ than those based on the best real characteristics.16
Finally, there is also another set of out-of-sample tests conducted by research-
ers that involves testing the robustness of the ¢ndings in a particular country (ty-
pically the United States) by using data from other countries. Such out-of-sample
tests have also been conducted in the value versus glamour literature, but with
mixed results. For example, Fama and French (1998) ¢nd strong evidence for the
‘‘value premium’’ in several countries during the 1975 to 1995 period. On the other
hand, in a recent paper, Fohlin and Bossaerts (2001) ¢nd that evidence from Ger-
many from a very di¡erent time period, 1881 to 1913, shows that the size e¡ect is
entirely due to selection bias, the momentum e¡ect does not exist, and although
there is a strong book-to-market e¡ect, it is of the opposite sign of the e¡ect un-
covered in the post-war U.S. data. Although our methodology is well suited for
testing the robustness of the international evidence to snooping biases, the execu-
tion of such a study is complicated by other factors. In particular, inadvertent
snooping in out-of-sample international studies can occur not only because of cor-
relations in the stock returns across markets, but also because of correlations
among the various ¢rm characteristics. Given the mixed evidence across di¡erent
markets, especially when di¡erent time periods are used (see Fohlin and Bos-
saerts (2001)), and the increased complexity of our simulation exercises with its
requirements of data availability, we defer such a study to the future.17
IV. Conclusion
The fragility of the one-factor Capital Asset Pricing Model (CAPM) in explain-
ing the cross section of expected returns of ¢nancial securities has led to a tre-
mendous resurgence of research aimed at discovering variables that might
explain the behavior of returns. Much of this research uses sorting procedures
16
Note that the decay rate analysis is conducted under the assumption that 5,000 searches
are conducted to discover the 15 ¢rm characteristics used. It is important to note, however,
that in our in-sample analysis, about 1,000 searches were su⁄cient to generate most of the in-
sample pro¢tability observed in the real data.
17
It is fairly easy to show however that for reasonably high correlations across stock mar-
kets, the probability of ¢nding similar ¢rm characteristics that can predict returns increases.
to uncover relations between combinations of ‘‘value versus glamour’’ ¢rm char-

acteristics and equity returns. In this paper, we examine the propensity of these
strategies to generate statistically and economically signi¢cant pro¢ts due to
data-snooping biases induced by our collective familiarity with the data. We are
particularly interested in the potential e¡ects of snooping because of our in-
creasing tendency to sort securities simultaneously on multiple characteristics.
We construct four di¡erent measures of data snooping, the di¡erences among
them hinging on the extent of snooping. All the measures are based on a simula-
tion technique that can be easily adapted to other scenarios. Under plausible as-
sumptions, our collective familiarity with the data could account for large
fractions of relations between well-known value and glamour ¢rm characteristics
reported in the literature. This is particularly the case when multiple ¢rm char-
acteristics are used simultaneously to sort ¢rms, an arguably natural and under-
standable trend in the literature given the inability of the one-factor model to
explain required returns on ¢nancial assets. The higher propensity for data
snooping in two-way (or even three-way) sorts exists because it is much easier
to generate a larger number of portfolios while simultaneously conditioning on
multiple characteristics. This tendency is exacerbated because multisort strate-
gies that generate the highest pro¢ts are also ones that sort ¢rms based on corre-
lated characteristics. We also present traditional and some new out-of-sample
tests to con¢rm our in-sample ¢ndings.
Our research is most closely related to the recent work of Lo and MacKinlay
(1990), Foster et al. (1997), Berk (1998), and Sullivan, Timmermann, and White
(1999, 2001), who statistically address the issue of data snooping, albeit with re-
spect to di¡erent applications. Lo and MacKinlay demonstrate that conducting
tests of asset pricing models on portfolios that have been formed on characteris-
tics of the data can lead to substantially higher and potentially spurious rejec-
tion rates of the null hypothesis. Similarly, Berk shows that the common
practice of sorting ¢rms into portfolios and then running asset pricing tests
within each group introduces a bias in favor of rejecting the model under consid-
eration. Foster et al. also focus on tests of asset pricing models, but examine the
biases in R2 measures when researchers choose k predictors from a larger set of
m possible variables. They propose variations in the traditional tests that re-
searchers use to assess whether a particular variable is predictable. Sullivan
et al. (1999) use a bootstrapping methodology to show the dominant e¡ects of
data snooping on technical trading rules, and the same authors show how a ‘‘sta-
tistical reality check’’ on the numerous well-publicized calendar e¡ects in stock
returns can also reveal their fragility (see Sullivan et al. (2001)).
Although these papers warn researchers about excessive familiarity with the
data when drawing inferences about tests of asset pricing models, most of the
recent empirical literature on asset pricing draws conclusions about the impor-
tance of ¢rm characteristics by emphasizing the economic pro¢ts or returns to
trading strategies based on sorting procedures using these characteristics. In
this important respect, our research is more pertinent to the large and rapidly
growing literature on empirical asset pricing. Another important aspect of our
work is that we assume that all the pro¢ts to trading strategies conditioned on
well-known and readily observable value versus glamour ¢rm characteristics are
‘‘excess’’ pro¢ts, over and above what should be earned as a reward for the risk(s)
of the strategies. Even under this extreme assumption, we are able to provide
support for the hypothesis that a large fraction of the reported relations between
equity returns and ¢rm characteristics could result from our collective familiar-
ity with the data.18 Depending on a researcher’s interpretation, this ¢nding could
make it easier to detect the sources of true pro¢tability, or allow a better focus on
the risk-based explanations of such predictability (see, e.g., Berk (1995), Fama and
French (1996), Berk, Green, and Naik (1999), and Ferson et al. (1999)).
Appendix
This appendix contains a list of all the ¢rm characteristics with their de¢ni-
tions in (Table AI), and the COMPUSTAT variables used in constructing them
(Table AII).
TableAI
Variable Construction
Cross-sectional variable
1. Price per share of common stock (P) Center for Research in Security Prices
(CRSP) price per share
2. Dividend^price ratio (D/P) (item201)/(item199)
3. Earnings^price ratio (E/P) (item58)/(item199)
4. Cash £ow^price ratio (C/P) (item18 þ item14)/ (item25 n item199)
5. Market value of equity (ME) CRSP price n CRSP number of shares
6. Total book^market equity ratio (B/ME) (item60 þ item74 þ item208 item130)/
(item25 n item199)
7. Book debt^equity ratio (D/E) (item9)/(item60)
8. Average ¢ve-year growth rate in sales (GS) (mean of the annual percent change in item
12 from year t to year t 4)/(standard
deviation of the annual percent change in
item 12 from year t to year t 4)
9. Return on investment (ROE) (item258)/(item216)
10. One-year returns (1-YEAR) 12-month holding period return from CRSP
11. Three-year returns (3 -YEAR) 36 -month holding period return from CRSP
Time-series variable
12. Price per share of common stock (P) Same as 1 above

13. Dividend^price ratio (D/P) Same as 2 above
14. Total book^market equity ratio (B/ME) Same as 6 above
15. One-year returns (1-YEAR) Same as 10 above
18
In related work, Ferson, Sarkissian, and Simin (1999) show that attribute-sorted portfo-
lios of common stocks will appear to be ‘‘risk factors’’ if the attributes are chosen following an
empirically observed relation to the cross section of stock returns.
TableAII
Compustat Annual Data Items De¢nition
9 Long-term total book debt

12 Net sales
14 Depreciation and amortization
18 Income before extraordinary items
25 Common shares outstanding
58 Earnings per share
60 Total common book equity
74 Deferred taxes, balance sheet
130 Preferred stock par value
199 Price of common stock, ¢scal year end
201 Dividends per share
208 Investment tax credit, balance sheet
216 Stockholders’equity
258 Net income adjusted for common stock equivalents
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THE JOURNAL OF FINANCE VOL. LVIII, NO.

Value versus Glamour

JENNIFER CONRAD, MICHAEL COOPER, and GAUTAM KAUL n

the apparent practice used in the literature,‘‘Nomono’’ implies that there is no ex

tage of our methodology is that we employ a portfolio formation technique that is

II. The Evidence

B. In-sample Pro¢ts: One-way Sorts

Portfolio Mean T-Stat. Std Min Max

Panel A: 5 -Portfolio Sort

L 1.32 4.55 0.17 1.06 1.60

Panel B: 10 -Portfolio Sort

L 1.37 4.30 0.20 0.99 1.63

Panel C: 30 -Portfolio Sort

L 1.48 3.91 0.33 0.93 2.10

Panel D: 50 -Portfolio Sort

L 1.53 3.73 0.43 0.94 2.48

Figure 1. Pro¢ts to one-way trading strategies implemented on randomized re-

ious, it is reassuring that a large fraction of the pro¢ts appear to be ‘‘real.’’

C. In-sample Pro¢ts: Two-way Sorts

Portfolio Mean T-Stat. Std Min Max

L 1.39 4.47 0.13 1.15 1.79

L 1.48 4.15 0.21 1.10 2.23

L 1.47 3.77 0.23 1.06 2.12

L 1.53 3.50 0.24 0.92 2.23

Figure 2. Pro¢ts to two-way trading strategies implemented on randomized re-

III. Out-of-sample Evidence

Real Data Simulated Data

Panel A: One-way and Two-way Regressions

One-way sorts Coe⁄cient on the number 0.0034 (2.01) 0.0075 (10.73)

Portfolio Mean T-Stat. Std Min Max

Panel A: One-way (10 -Portfolio) Sort

L 1.25 4.13 0.18 0.88 1.54

Panel B: One-way (50 -Portfolio) Sort

L 1.25 3.49 0.35 0.48 1.87

Panel C: Two-way (3 3) Sort

L 1.22 4.37 0.13 0.94 1.50

Panel D: Two-way (7 7) Sort

L 1.27 3.59 0.25 0.61 2.04

The Journal of Finance

Real Sorts Random Sorts

Mean Std Min Max Mean Std Min Max

Panel A: One-way (10 -Portfolio) Sort

Panel B: One-way (50 -Portfolio) Sort

Panel C: Two-way (3 3) Sort

Panel D: Two-way (7 7) Sort

to uncover relations between combinations of ‘‘value versus glamour’’ ¢rm char-

12. Price per share of common stock (P) Same as 1 above

Compustat Annual Data Items De¢nition

9 Long-term total book debt

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