Reverse Survivorship Bias

Abstract:     
Mutual funds often disappear following poor performance. When this poor performance is partly attributable to negative idiosyncratic shocks, funds' estimated alphas understate their true alphas. This paper estimates a structural model to correct for this bias. Although most funds still have negative alphas, they are not nearly as low as those suggested by the fund-by-fund regressions. Approximately 12% of funds have net four-factor model alphas greater than 2% per year. All studies that run fund-by-fund regressions to draw inferences about the prevalence of skill among mutual fund managers are subject to reverse survivorship bias.

Number of Pages in PDF File: 49

Keywords: Mutual Funds, Performance Evaluation, Reverse Survivorship Bias

JEL Classification: C11, G11, G12

Accepted Paper Series