Performance Measurement with Uncertain Risk Loadings
Francesco A. Franzoni
University of Lugano; Swiss Finance Institute
Martin C. Schmalz
University of Michigan, Stephen M. Ross School of Business
October 24, 2014
Swiss Finance Institute Research Paper No. 13-41
Ross School of Business Paper No. 1194
We study the implications of uncertainty about risk loadings for mutual fund investors' capital allocation decisions. We show that the signal-to-noise ratio is higher and rational investors give more weight to performance signals when market returns are moderate, compared to times of very high or low market returns. Consistent with the model predictions, the flow-performance relation is about twice as steep in moderate times, and the difference is larger for types of funds with more uncertainty about risk loadings. The model-implied degree of parameter uncertainty is consistent with direct estimates of parameter uncertainty from fund holdings and daily returns.
Number of Pages in PDF File: 67
Keywords: Bayesian learning, parameter uncertainty, mutual funds, flow-performance
JEL Classification: G00, G20
Date posted: May 13, 2013 ; Last revised: February 25, 2015
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