On the Use of Multifactor Models to Evaluate Mutual Fund Performance
Erasmus University - Rotterdam School of Management; Robeco Quantitative Strategies; Erasmus University Rotterdam (EUR) - Erasmus Research Institute of Management (ERIM)
Erasmus University - Rotterdam School of Management; Erasmus Research Institute of Management (ERIM); Netspar
Financial Management, Spring 2009
We show that multifactor performance estimates for mutual funds suffer from systematic biases, and argue that these biases are a result of miscalculating the factor premiums. Because the factor proxies are based on hypothetical stock portfolios and do not incorporate transaction costs, trade impact, and trading restrictions, the factor premiums are either over- or underestimated. We argue that factor proxies based on mutual fund returns rather than stock returns provide better benchmarks to evaluate professional money managers.
Keywords: mutual fund performance, model misspecification, value premium, momentum premium
JEL Classification: G11, G14, G19Accepted Paper Series
Date posted: November 23, 2007 ; Last revised: May 6, 2009
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