False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas

83 Pages Posted: 5 Mar 2008 Last revised: 23 Jun 2022

See all articles by Laurent Barras

Laurent Barras

Universite du Luxembourg - Department of Finance

O. Scaillet

Swiss Finance Institute - University of Geneva

Russ Wermers

University of Maryland - Robert H. Smith School of Business; European Corporate Governance Institute (ECGI)

Date Written: April 20, 2009

Abstract

This paper develops a simple technique that controls for “false discoveries,” or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero-alpha, and (3) skilled funds, even with dependencies in cross-fund estimated alphas. We find that 75% of funds exhibit a zero alpha (net of expenses), consistent with the Berk and Green (2004) equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find funds with persistent performance.

Keywords: Mutual Fund Performance, Multiple-Hypothesis Test, Luck, False Discovery Rate

JEL Classification: G11, G23, C12

Suggested Citation

Barras, Laurent and Scaillet, Olivier and Wermers, Russell R., False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas (April 20, 2009). Published in Journal of Finance, February 2010, Swiss Finance Institute Research Paper No. 08-18, Robert H. Smith School Research Paper No. RHS 06-043, Available at SSRN: https://ssrn.com/abstract=869748

Laurent Barras (Contact Author)

Universite du Luxembourg - Department of Finance ( email )

L-1511 Luxembourg
Luxembourg

Olivier Scaillet

Swiss Finance Institute - University of Geneva ( email )

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://terpconnect.umd.edu/~wermers/

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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