Idiosyncratic Risk and Mutual Fund Performance
36 Pages Posted: 15 Nov 2013 Last revised: 20 Feb 2018
Date Written: January 1, 2018
This paper examines the relation between idiosyncratic risk and mutual fund performance using asset pricing models. We use a unique data set containing monthly returns of 949 UK equity mutual funds over a 28-year period to measure fund performance. We find that idiosyncratic risk cannot be eliminated in UK mutual funds. We show that idiosyncratic risk is negatively related to returns for all funds investment style categories. We present evidence that the inclusion of idiosyncratic risk significantly increases the number of funds showing statistically significant and positive selectivity skills (alpha). Furthermore, all equity mutual funds turn to show significant volatility timing performance when idiosyncratic risk is considered. Finally, we find that idiosyncratic risk can forecast fund returns after controlling for macroeconomic variables.
Keywords: Mutual fund performance, idiosyncratic risk, investment style, market timing
JEL Classification: G11, G12, G14
Suggested Citation: Suggested Citation