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Fooled by Randomness: Investor Perception of Fund Manager Skill

Author

Listed:
  • Justus Heuer
  • Christoph Merkle
  • Martin Weber

Abstract

Return-chasing investors almost exclusively consider top-performing funds for their investment decisions. When drawing conclusions about the managerial skill of these top performers, they tend to neglect fund volatility and the cross-sectional information contained in the number of funds and the distribution of skill. In multiple surveys of sophisticated retail investors, we show that they do not fully understand the role of chance in experimental samples of fund populations. Respondents evaluate each fund in isolation and do not sufficiently account for fund volatility. They confuse risk taking with manager skill and are thus likely to over-allocate capital to lucky past winners.

Suggested Citation

  • Justus Heuer & Christoph Merkle & Martin Weber, 2017. "Fooled by Randomness: Investor Perception of Fund Manager Skill," Review of Finance, European Finance Association, vol. 21(2), pages 605-635.
    • Handle: RePEc:oup:revfin:v:21:y:2017:i:2:p:605-635.
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    File URL: http://hdl.handle.net/10.1093/rof/rfw011
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    Citations

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    Cited by:

    1. Kim, Donghyun & Li, Chengcheng & Wang, Xiaoqiong, 2023. "Liquidity Dry-ups in equity markets," International Review of Financial Analysis, Elsevier, vol. 86(C).
    2. Raphael Flepp & Oliver Merz & Egon Franck, 2024. "When the league table lies: Does outcome bias lead to informationally inefficient markets?," Economic Inquiry, Western Economic Association International, vol. 62(1), pages 414-429, January.
    3. Christoph Merkle & Philipp Schreiber & Martin Weber, 2017. "Framing and retirement age: The gap between willingness-to-accept and willingness-to-pay," Economic Policy, CEPR, CESifo, Sciences Po;CES;MSH, vol. 32(92), pages 757-809.
    4. Fildes, Robert & Goodwin, Paul, 2021. "Stability in the inefficient use of forecasting systems: A case study in a supply chain company," International Journal of Forecasting, Elsevier, vol. 37(2), pages 1031-1046.
    5. Duffy, John & Rabanal, Jean Paul & Rud, Olga A., 2021. "The impact of ETFs in secondary asset markets: Experimental evidence," Journal of Economic Behavior & Organization, Elsevier, vol. 188(C), pages 674-696.
    6. Merkle, Christoph, 2018. "The curious case of negative volatility," Journal of Financial Markets, Elsevier, vol. 40(C), pages 92-108.

    More about this item

    JEL classification:

    • G02 - Financial Economics - - General - - - Behavioral Finance: Underlying Principles
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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