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

TY - JOUR

T1 - Reassessing False Discoveries in Mutual Fund Performance

T2 - Skill, Luck, or Lack of Power?

AU - Andrikogiannopoulou, Angie

AU - Papakonstantinou, Filippos

PY - 2019/10/1

Y1 - 2019/10/1

N2 - Barras, Scaillet, and Wermers propose the false discovery rate (FDR) to separate skill (alpha) from luck in fund performance. Using simulations with parameters informed by the data, we find that this methodology is conservative and underestimates the proportion of nonzero-alpha funds. For example, 65% of funds with economically large alphas of (Formula presented.) are misclassified as zero alpha. This bias arises from the low signal-to-noise ratio in fund returns and the resulting low statistical power. Our results question FDR's applicability in performance evaluation and other domains with low power, and can materially change the conclusion that most funds have zero alpha.

AB - Barras, Scaillet, and Wermers propose the false discovery rate (FDR) to separate skill (alpha) from luck in fund performance. Using simulations with parameters informed by the data, we find that this methodology is conservative and underestimates the proportion of nonzero-alpha funds. For example, 65% of funds with economically large alphas of (Formula presented.) are misclassified as zero alpha. This bias arises from the low signal-to-noise ratio in fund returns and the resulting low statistical power. Our results question FDR's applicability in performance evaluation and other domains with low power, and can materially change the conclusion that most funds have zero alpha.

KW - Mutual Funds

KW - Skill

KW - Performance

KW - False Discovery Rate

KW - Simulation

UR - http://www.scopus.com/inward/record.url?scp=85066051812&partnerID=8YFLogxK

U2 - 10.1111/jofi.12784

DO - 10.1111/jofi.12784

M3 - Article

SN - 0022-1082

VL - 74

SP - 2667

EP - 2688

JO - JOURNAL OF FINANCE

JF - JOURNAL OF FINANCE

IS - 5

ER -