Resisting the Manipulation of Performance Metrics: An Empirical Analysis of The Manipulation-Proof Performance Measure

Abstract

Performance manipulation can make a fund more attractive to investors and, more seriously, managers can intentionally misreport returns to enhance performance scores. This paper empirically investigates whether the manipulation-proof performance measure derived by Goetzmann et al. (2007) really is impervious to performance anipulation, using TASS hedge fund data, which have very skewed and fat-tailed return distributions. This article determines that the MPPM can evaluate performance more correctly than other measures. At application level, we propose the Doubt Ratio (DR), a new simple measure to detect funds that might have been manipulated or whose returns were intentionally smoothed, as in Madoff’s case. Our findings will help investors select funds and financial supervisors filter out funds for further investigation.

Keywords: Performance Measure, Performance Manipulation, Return Smoothing, Doubt Ratio, Madoff

JEL Classification: C10, G10, G20