False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas
McGill University - Desautels Faculty of Management
University of Geneva GSEM and GFRI; Swiss Finance Institute
University of Maryland - Robert H. Smith School of Business
April 20, 2009
Journal of Finance, Forthcoming
Swiss Finance Institute Research Paper No. 08-18
Robert H. Smith School Research Paper No. RHS 06-043
This paper develops a simple technique that controls for “false discoveries,” or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero-alpha, and (3) skilled funds, even with dependencies in cross-fund estimated alphas. We find that 75% of funds exhibit a zero alpha (net of expenses), consistent with the Berk and Green (2004) equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find funds with persistent performance.
Number of Pages in PDF File: 53
Keywords: Mutual Fund Performance, Multiple-Hypothesis Test, Luck, False Discovery Rate
JEL Classification: G11, G23, C12
Date posted: March 5, 2008 ; Last revised: February 3, 2011
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