Computing DGTW Characteristic-Adjusted Stock Returns

Summary

DGTW adjusted returns measure a stock’s performance relative to a characteristic-matched benchmark. For each stock, the method subtracts the return of a portfolio of firms assigned to matching groups based on market equity, market-to-book ratio, and prior one-year return. The resulting abnormal return is intended to isolate performance beyond what might be associated with those characteristics.

The document places this method in the context of evaluating mutual fund stock selection and notes that the same benchmark logic can be applied to other stock-picking approaches, including algorithms. It identifies the original characteristic-based benchmark study but does not detail portfolio formation, rebalancing, treatment of missing data, or statistical tests. Adjusted returns are therefore a comparison measure, not by themselves proof of manager or strategy skill; interpretation depends on benchmark construction and the broader evaluation design.

Key ideas

• DGTW return is a stock’s return minus that of a portfolio matched on selected characteristics.
• The matching dimensions are market equity, market-to-book, and prior one-year return.
• The measure is used to assess performance beyond characteristic-based benchmarks.
• It can be applied when evaluating stock-picking algorithms as well as fund managers.
• Adjusted performance alone does not establish skill without considering benchmark design and evaluation methods.

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# What are DGTW adjusted returns?


# What are DGTW adjusted returns?












Many papers, e.g. in The Journal of Finance, discuss DGTW adjusted returns (or DGTW abnormal returns) instead of just returns.

What are these and how does one compute them?

## Answer by user1157 (score 4, accepted)

https://quant.stackexchange.com/a/10044

Following Daniel, Grinblatt, Titman, and Wermers (1997) "D.G.T.W.!", DGTW subtracts from each stock return the return on a portfolio of firms matched on market equity, market-book, and prior one-year return quintiles.

Daniel, K., Grinblatt, M., Titman, S., Wermers, R., 1997. Measuring mutual fund performance with characteristic-based benchmarks, Journal of Finance 52, 1035–1058.

The DGTW paper tries to decide whether stock funds are good in picking stocks and timing the market. My understanding is that the intended application of DGTW returns is to have a criterion for stocks which outperfrom its benchmark and then make conclusions about the stock-picking abilities of the fund manager. Of course the same principle applies for other stock picking entities, such as computer algorithms.

Edit: you can download the benchmark returns from the homepage of one of the authors.

Shown in full with attribution under the source's licence. Licence: CC BY-SA 4.0 (Stack Exchange)

This summary was written by Stratmill's research agent from the original; it is not a copy of the source.