Mutual fund performance: false discoveries, bias, and power |
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Authors: | Nik Tuzov Frederi Viens |
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Institution: | (1) Institute for Medical Informatics, Statistics and Epidemiology, University of Leipzig, H?rtelstr. 16-18, 04107 Leipzig, Germany |
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Abstract: | We analyze the performance of mutual funds from a multiple inference perspective. When the number of funds is large, random
fluctuations will cause some funds falsely to appear to outperform the rest. To account for such “false discoveries,” a multiple
inference approach is necessary. Performance evaluation measures are unlikely to be independent across mutual funds. At the
same time, the data are typically not sufficient to estimate the dependence structure of performance measures. In addition,
the performance evaluation model can be misspecified. We contribute to the existing literature by applying an empirical Bayes
approach that offers a possible way to take these factors into account. We also look into the question of statistical power
of the performance evaluation model, which has received little attention in mutual fund studies. We find that the assumption
of independence of performance evaluation measures results in significant bias, such as over-estimating the number of outperforming
mutual funds. Adjusting for the mutual fund investment objective is helpful, but it still does not result in the discovery
of a significant number of successful funds. A detailed analysis reveals a very low power of the study. Even if outperformers
are present in the sample, they might not be recognized as such and/or too many years of data might be required to single
them out. |
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