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Return-based style analysis with time-varying exposures

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  • Laurens Swinkels
  • Pieter Van Der Sluis

Abstract

This paper focuses on the estimation of mutual fund styles by return-based style analysis. Often the investment style is assumed to be constant through time. Alternatively, time variation is sometimes implicitly accounted for by using rolling regressions when estimating the style exposures. The former assumption is often contradicted empirically, and the latter is inefficient due to its ad hoc chosen window size. Here, the Kalman filter is used to model time-varying exposures of mutual funds explicitly. This leads to a testable model and more efficient use of the data, which reduces the influence of spurious correlation between mutual fund returns and style indices. Several stylized examples indicate that more reliable style estimates can be obtained by modelling the style exposure as a random walk, and estimating the coefficients with the Kalman filter. The differences with traditional techniques are substantial in these stylized examples. The results from the empirical analyses indicate that the structural model estimated by the Kalman filter improves style predictions and influences results on performance measurement.

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Bibliographic Info

Article provided by Taylor & Francis Journals in its journal The European Journal of Finance.

Volume (Year): 12 (2006)
Issue (Month): 6-7 ()
Pages: 529-552

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Handle: RePEc:taf:eurjfi:v:12:y:2006:i:6-7:p:529-552

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Keywords: Dynamic models; Kalman filter; Mutual funds; Style analysis;

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Cited by:
  1. Darolles, Serge & Vaissié, Mathieu, 2012. "The alpha and omega of fund of hedge fund added value," Journal of Banking & Finance, Elsevier, vol. 36(4), pages 1067-1078.
  2. Bohl, Martin T. & Kaufmann, Philipp & Stephan, Patrick M., 2013. "From hero to zero: Evidence of performance reversal and speculative bubbles in German renewable energy stocks," Energy Economics, Elsevier, vol. 37(C), pages 40-51.
  3. Holmes, Kathryn A. & Faff, Robert, 2008. "Estimating the performance attributes of Australian multi-sector managed funds within a dynamic Kalman filter framework," International Review of Financial Analysis, Elsevier, vol. 17(5), pages 998-1011, December.
  4. Martin Bohl & Philipp Kaufmann & Patrick Stephan, 2012. "From Hero to Zero: Evidence of Performance Reversal and Speculative Bubbles in German Renewable Energy Stocks," CQE Working Papers 2412, Center for Quantitative Economics (CQE), University of Muenster.

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