Articlebronze2010

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

Laurent Barras · Olivier Scaillet B · Russ R. Wermers

825 citations0/0 files storedThe Journal of Finance

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Financial Markets and Investment Strategies Corporate Finance and Governance Financial Analysis and Corporate Governance

Abstract

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 zero alpha (net of expenses), consistent with the Berk and Green 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 the few funds with persistent performance.

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References

1993Common risk factors in the returns on stocks and bonds 1997On Persistence in Mutual Fund Performance 1996Multifactor Explanations of Asset Pricing Anomalies 1968THE PERFORMANCE OF MUTUAL FUNDS IN THE PERIOD 1945–1964 1982Regret Theory: An Alternative Theory of Rational Choice Under Uncertainty 1998Costly Search and Mutual Fund Flows 1982Regret in Decision Making under Uncertainty 1997Measuring Mutual Fund Performance with Characteristic‐Based Benchmarks

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