Fooled by Randomness: Investor Perception of Fund Manager Skill
Review of Finance, 2017, Vol. 21, No. 2, pp. 605-635. This is the accepted version of doi: 10.1093/rof/rfw011
48 Pages Posted: 9 Sep 2014 Last revised: 2 Apr 2018
Date Written: February 24, 2016
Return-chasing investors almost exclusively consider top-performing funds for their investment decisions. When drawing conclusions about the managerial skill of these top performers, they tend to neglect fund volatility and the cross-sectional information contained in the number of funds and the distribution of skill. In multiple surveys of sophisticated retail investors, we show that they do not fully understand the role of chance in experimental samples of fund populations. Respondents evaluate each fund in isolation and do not sufficiently account for fund volatility. They confuse risk taking with manager skill and are thus likely to over-allocate capital to lucky past winners.
Keywords: Mutual Fund Performance, Skill, Luck, Return Chasing, False Discovery
JEL Classification: G02, G11, G23
Suggested Citation: Suggested Citation