How Many Good and Bad Funds Are There, Really?
89 Pages Posted: 15 Aug 2015 Last revised: 19 Oct 2018
Date Written: April 18, 2018
Building on the work of Barras, Scaillet and Wermers (BSW, 2010), we propose a modified approach to inferring performance for a cross-section of investment funds. Our model assumes that funds belong to groups of different abnormal performance or alpha. Using the structure of the probability model, we simultaneously estimate the alpha locations and the fractions of funds for each group, taking multiple testing into account. Our approach allows for tests with imperfect power that may falsely classify good funds as bad, and vice versa. Examining both mutual funds and hedge funds, we find smaller fractions of zero-alpha funds and more funds with abnormal performance, compared with the BSW approach. We also use the model as prior information about the cross-section of funds to evaluate and predict fund performance.
Keywords: Hedge Fund, Mutual fund, Fund performance, False discovery rates, Bayes rule, Bootstrap, Goodness of fit, Test power, Trading Strategies, Kernel Smoothing
JEL Classification: G11, G23, C12
Suggested Citation: Suggested Citation