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

53 Pages Posted: 5 Mar 2008 Last revised: 3 Feb 2011

Laurent Barras

McGill University - Desautels Faculty of Management

O. Scaillet

University of Geneva GSEM and GFRI; Swiss Finance Institute

Russ Wermers

University of Maryland - Robert H. Smith School of Business

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 , O. and Wermers, Russ, False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas (April 20, 2009). Journal of Finance, Forthcoming; 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)

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

40, Boulevard du Pont-d'Arve
40, Bd du Pont-d'Arve
1211 Geneva 4, CH-6900
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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