A Conditional CAPM Model with Local Covariates for Detecting and Evaluating Active Management

Abstract

The intercept of the standard CAPM and Conditional CAPM model, the alpha, is used to evaluate the long-run performance of managed portfolios. However, this measure is not always appropriate for detecting the presence and impact of active management strategies. In this paper, we introduce a Conditional CAPM model where the time-varying alpha and beta parameters depend only on the past history of the underlying portfolio returns and of the benchmark returns. The dynamics of the parameters has two components: the first describes the long-term behavior of the alpha and beta, whereas the second is associated with the short-term performance of the underlying portfolio. The interpretation of parameters allows the identification of portfolio managers who implement active management strategies. We provide an empirical application based on a large set of U.S. mutual funds showing how widespread active management approaches are, even if only a minor fraction persistently beats the benchmark. We also show that the recent financial crisis has had negative effects on mutual fund performances.

Keywords: conditional CAPM, time-varying parameters, local covariates, mutual funds

JEL Classification: G11, C51, C52, G23, C22