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

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  • Klaas P. 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.

Suggested Citation

  • Klaas P. Baks & Andrew Metrick & Jessica Wachter, 2001. "Should Investors Avoid All Actively Managed Mutual Funds? A Study in Bayesian Performance Evaluation," Journal of Finance, American Finance Association, vol. 56(1), pages 45-85, February.
    • Handle: RePEc:bla:jfinan:v:56:y:2001:i:1:p:45-85
    DOI: 10.1111/0022-1082.00319
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