Mutual Fund Performance with Learning Across Funds

54 Pages Posted: 6 Jun 2003

See all articles by Christopher S. Jones

Christopher S. Jones

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Jay A. Shanken

Emory University - Goizueta Business School; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: December 3, 2002

Abstract

This paper is based on the premise that knowledge about the alphas of one set of funds will influence an investor's beliefs about other funds. This will be true insofar as an investor's expectation about the performance of a fund is partly a belief about the abilities of mutual fund managers as a group and, more generally, a belief about the degree to which financial markets are efficient. We develop a simple framework for incorporating this "prior dependence" and find that it can have a substantial impact on the cross-section of posterior beliefs about fund performance. Under independence, the maximum posterior mean alpha increases without bound as the number of funds increases and "extremely large" estimates are randomly observed. This is true even when fund managers have no skill. In contrast, with prior dependence, investors aggregate information across funds to form a general belief about the potential for abnormal performance. Each fund's alpha estimate is shrunk toward the aggregate estimate, mitigating extreme views. An additional implication is that restricting the estimation to surviving funds, a common practice in this literature, imparts an upward bias to the average fund alpha.

Keywords: mutual funds, asset allocation, Bayesian analysis, asset pricing

JEL Classification: G12, G11, G23

Suggested Citation

Jones, Christopher S. and Shanken, Jay A., Mutual Fund Performance with Learning Across Funds (December 3, 2002). Available at SSRN: https://ssrn.com/abstract=357783 or http://dx.doi.org/10.2139/ssrn.357783

Christopher S. Jones (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States

Jay A. Shanken

Emory University - Goizueta Business School ( email )

1300 Clifton Road
Atlanta, GA 30322-2722
United States
404-727-4772 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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