A Skeptical Appraisal of the Bootstrap Approach in Fund Performance Evaluation

38 Pages Posted: 16 Apr 2018

See all articles by Huazhu Zhang

Huazhu Zhang

Nomura Group

Cheng Yan

Durham Business School

Date Written: May 2018

Abstract

It has become standard practice in the fund performance evaluation literature to use the bootstrap approach to distinguish “skills” from “luck”, while its reliability has not been subject to rigorous statistical analysis. This paper reviews and critiques the bootstrap schemes used in the literature, and provides a simulation analysis of the validity and reliability of the bootstrap approach by applying it to evaluating the performance of hypothetical funds under various assumptions. We argue that this approach can be misleading, regardless of using alpha estimates or their t‐statistics. While alternative bootstrap schemes can result in improvements, they are not foolproof either. The case can be worse if the benchmark model is misspecified. It is therefore only with caution that we can use the bootstrap approach to evaluate the performance of funds and we offer some suggestions for improving it.

Keywords: alpha, bootstrapping, Fama–French model, Monte Carlo simulation, performance evaluation

JEL Classification: C15, G11

Suggested Citation

Zhang, Huazhu and Yan, Cheng, A Skeptical Appraisal of the Bootstrap Approach in Fund Performance Evaluation (May 2018). Financial Markets, Institutions & Instruments, Vol. 27, Issue 2, pp. 49-86, 2018, Available at SSRN: https://ssrn.com/abstract=3163166 or http://dx.doi.org/10.1111/fmii.12093

Huazhu Zhang (Contact Author)

Nomura Group ( email )

Japan

Cheng Yan

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

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