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False discoveries in mutual fund performance: Measuring luck in estimated alphas

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  • Barras, Laurent
  • Scaillet, Olivier
  • Wermers, Russ

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 a zero alpha (net of expenses), consistent with the Berk and Green (2004) 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 funds with persistent performance.

Suggested Citation

  • Barras, Laurent & Scaillet, Olivier & Wermers, Russ, 2009. "False discoveries in mutual fund performance: Measuring luck in estimated alphas," CFR Working Papers 06-02, University of Cologne, Centre for Financial Research (CFR).
    • Handle: RePEc:zbw:cfrwps:0602
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    More about this item

    Keywords

    Mutual Fund Performance; Multiple-Hypothesis Test; Luck; False Discovery Rate;
    All these keywords.

    JEL classification:

    • 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
    • C12 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Hypothesis Testing: General

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