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Limits to mutual funds' ability to rely on mean/variance optimization

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  • Karagiannidis, Iordanis
  • Vozlyublennaia, Nadia

Abstract

Our evidence suggests that estimation error in the required statistics is an important factor inhibiting investors' ability to rely on mean/variance analysis. We compare the returns reported by mutual funds to the returns obtained from a mean/variance optimized portfolio of fund holdings. The results suggest that funds tend to outperform the optimized portfolio out-of-sample (when means/variances/covariances are unknown), but under-perform in-sample (when the required statistics in the optimization are known). Therefore, a popular assumption in asset pricing models that investors rely on a basic mean/variance analysis with known underlying statistics is likely to be grossly violated in the case of mutual funds.

Suggested Citation

  • Karagiannidis, Iordanis & Vozlyublennaia, Nadia, 2016. "Limits to mutual funds' ability to rely on mean/variance optimization," Journal of Empirical Finance, Elsevier, vol. 37(C), pages 282-292.
  • Handle: RePEc:eee:empfin:v:37:y:2016:i:c:p:282-292
    DOI: 10.1016/j.jempfin.2016.01.008
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    More about this item

    Keywords

    Estimation risk; Portfolio optimization; Mutual funds;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • 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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