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Should Investors Avoid All Actively Managed Mutual Funds? A Study in Bayesian Performance Evaluation

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  • Klaas Baks
  • Andrew Metrick
  • Jessica Wachter

Abstract

This paper analyzes mutual-fund performance from an investor's perspective. We study the portfolio-choice problem for a mean-variance investor choosing among a risk-free asset, index funds, and actively managed mutual funds. To solve this problem, we employ a Bayesian method of performance evaluation; a key innovation in our approach is the development of a flexible set of prior beliefs about managerial skill. We then apply our methodology to a sample of 1,437 mutual funds. We find that some extremely skeptical prior beliefs nevertheless lead to economically significant allocations to active managers. Copyright The American Finance Association 2001.

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Bibliographic Info

Paper provided by Wharton School Rodney L. White Center for Financial Research in its series Rodney L. White Center for Financial Research Working Papers with number 18-99.

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Handle: RePEc:fth:pennfi:18-99

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  1. Lubos Pastor & Robert F. Stambaugh, 1999. "Comparing Asset Pricing Models: An Investment Perspective," NBER Working Papers 7284, National Bureau of Economic Research, Inc.
  2. Philippe Jorion & William N. Goetzmann, 1998. "Re-Emerging Markets," Yale School of Management Working Papers ysm111, Yale School of Management.
  3. Elton, Edwin J & Gruber, Martin J & Blake, Christopher R, 1996. "The Persistence of Risk-Adjusted Mutual Fund Performance," The Journal of Business, University of Chicago Press, vol. 69(2), pages 133-57, April.
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  7. William N. Goetzmann & Stephen J. Brown, 2005. "Performance Persistence," Yale School of Management Working Papers ysm451, Yale School of Management.
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  19. Ferson, Wayne E & Schadt, Rudi W, 1996. " Measuring Fund Strategy and Performance in Changing Economic Conditions," Journal of Finance, American Finance Association, vol. 51(2), pages 425-61, June.
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  23. Carlson, Robert S., 1970. "Aggregate Performance of Mutual Funds, 1948–1967," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 5(01), pages 1-32, March.
  24. Shanken, Jay, 1987. "A Bayesian approach to testing portfolio efficiency," Journal of Financial Economics, Elsevier, vol. 19(2), pages 195-215, December.
  25. Frost, Peter A. & Savarino, James E., 1986. "An Empirical Bayes Approach to Efficient Portfolio Selection," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 21(03), pages 293-305, September.
  26. Brown, Stephen J, et al, 1992. "Survivorship Bias in Performance Studies," Review of Financial Studies, Society for Financial Studies, vol. 5(4), pages 553-80.
  27. Fama, Eugene F. & French, Kenneth R., 1993. "Common risk factors in the returns on stocks and bonds," Journal of Financial Economics, Elsevier, vol. 33(1), pages 3-56, February.
  28. Goetzmann, W.N. & Ibbotson, R.G., 1990. "Do Winners Repeat? Patterns in Mutual Fund Behavior," Papers fb-_91-04, Columbia - Graduate School of Business.
  29. Klaas Baks & Andrew Metrick & Jessica Wachter, 1999. "Bayesian Performance Evaluation," NBER Working Papers 7069, National Bureau of Economic Research, Inc.
  30. Lehmann, Bruce N & Modest, David M, 1987. " Mutual Fund Performance Evaluation: A Comparison of Benchmarks and Benchmark Comparisons," Journal of Finance, American Finance Association, vol. 42(2), pages 233-65, June.
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