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

Research output: Contribution to journalArticlepeer-review

28 Citations (Scopus)
429 Downloads (Pure)

Abstract

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.

Original languageEnglish
Pages (from-to)2667-2688
Number of pages22
JournalJOURNAL OF FINANCE
Volume74
Issue number5
Early online date15 May 2019
DOIs
Publication statusPublished - 1 Oct 2019

Keywords

  • Mutual Funds
  • Skill
  • Performance
  • False Discovery Rate
  • Simulation

Fingerprint

Dive into the research topics of 'Reassessing False Discoveries in Mutual Fund Performance: Skill, Luck, or Lack of Power?'. Together they form a unique fingerprint.

Cite this