Cross-Sectional Alpha Dispersion and Performance Evaluation
82 Pages Posted: 24 Mar 2018 Last revised: 24 Jul 2018
Date Written: July 20, 2018
Our paper explores the link between cross-sectional fund return dispersion and performance evaluation. The foundation of our model is the simple intuition that in periods of high return dispersion, which is associated with high levels of idiosyncratic risk for zero-alpha funds, it is easier for unskilled managers to disguise themselves as skilled. Rational investors should be more skeptical and apply larger discounts to reported performance in high dispersion environments. Our empirical results are consistent with this prediction. Using fund flow data, we show that a one-standard deviation increase in cross-sectional return dispersion is associated with an 11% to 17% decline in flow-performance sensitivity. The effect is stronger for recent data and among outperforming funds.
Keywords: Hedge funds, Mutual funds, Performance evaluation, Bayesian, Appraisal ratio, Flow-performance sensitivity, Idiosyncratic risk
JEL Classification: G11, G14, G23
Suggested Citation: Suggested Citation