Reassessing False Discoveries in Mutual Fund Performance: Skill, Luck, or Lack of Power? A Reply

37 Pages Posted: 21 Aug 2019

See all articles by Laurent Barras

Laurent Barras

McGill University - Desautels Faculty of Management

O. Scaillet

University of Geneva GSEM and GFRI; Swiss Finance Institute; University of Geneva - Research Center for Statistics

Russ Wermers

University of Maryland - Robert H. Smith School of Business

Date Written: October 24, 2019

Abstract

Andrikogiannopoulou and Papakonstantinou (AP; 2019) conduct an inquiry into the bias of the False Discovery Rate (FDR) estimators of Barras, Scaillet, and Wermers (BSW; 2010). In this Reply, we replicate their results, then further explore the bias issue by (i) using different parameter values, and (ii) updating the sample period. Over the original period (1975-2006), we show how reasonable adjustments to the parameter choices made by BSW and AP results in a sizeable reduction in the bias relative to AP. Over the updated period (1975-2018), we further show that the performance of the FDR improves dramatically across a large range of parameter values. Specifically, we find that the probability of misclassifying a fund with a true alpha of 2% per year is 32% (versus 65% in AP). Our results, in combination with those of AP, indicate that the use of the FDR in finance should be accompanied by a careful evaluation of the underlying data generating process, especially when the sample size is small.

Keywords: False Discovery Rate, Multiple Testing, Mutual Fund Performance

JEL Classification: C11, G12, G23

Suggested Citation

Barras, Laurent and Scaillet, Olivier and Wermers, Russell R., Reassessing False Discoveries in Mutual Fund Performance: Skill, Luck, or Lack of Power? A Reply (October 24, 2019). Swiss Finance Institute Research Paper No. 19-61. Available at SSRN: https://ssrn.com/abstract=3439231 or http://dx.doi.org/10.2139/ssrn.3439231

Laurent Barras (Contact Author)

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada
+15143988862 (Phone)

Olivier Scaillet

University of Geneva GSEM and GFRI ( email )

40 Boulevard du Pont d'Arve
Geneva 4, 1211
Switzerland
+ 41 22 379 88 16 (Phone)
+41 22 389 81 04 (Fax)

HOME PAGE: http://www.scaillet.ch

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

University of Geneva - Research Center for Statistics

Geneva
Switzerland

Russell R. Wermers

University of Maryland - Robert H. Smith School of Business ( email )

Department of Finance
College Park, MD 20742-1815
United States
301-405-0572 (Phone)
301-405-0359 (Fax)

HOME PAGE: http://www.rhsmith.umd.edu/finance/rwermers/

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