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Reverse Survivorship Bias

49 Pages Posted: 12 Apr 2010 Last revised: 17 Nov 2011

Juhani T. Linnainmaa

USC Marshall School of Business; National Bureau of Economic Research (NBER)

Date Written: November 7, 2011

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.

Keywords: Mutual Funds, Performance Evaluation, Reverse Survivorship Bias

JEL Classification: C11, G11, G12

Suggested Citation

Linnainmaa, Juhani T., Reverse Survivorship Bias (November 7, 2011). Journal of Finance, Forthcoming; Western Finance Association 2010 Conference; CRSP Working Paper; Chicago Booth Research Paper No. 10-17. Available at SSRN: https://ssrn.com/abstract=1588146

Juhani Linnainmaa (Contact Author)

USC Marshall School of Business ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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