Galton's Error and the under-representation of systematic risk
Our methodology of 'complete identification,' using simple algebraic geometry, throws new light on the continued commitment of Galton's Error in finance and the resulting misinformation of investors. Mutual funds conventionally advertise their relative systematic market risk, or 'betas,' to potential investors based on incomplete measurement by unidirectional bivariate projections: they commit Galton's Error by under-representing their systematic risk. Consequently, far too many mutual funds are marketed as 'defensive' and too few as 'aggressive.' Using our new methodology we found that, out of a total of 3,217 mutual funds, 2,047 funds (63.7%) claimed to be defensive based on the current industry standard methodology, but only 608 (18.9%) actually are. This under-representation of systematic risk leads to inefficiencies in the capital allocation process, since biased betas lead to mis-pricing of mutual funds. Our complete bivariate projection produces a correct representation of the epistemic uncertainty inherent in the bivariate measurement of relative market risk. Our conclusions have also serious consequences for the proper 'bench-marking' and recent regulatory proposals for the mutual funds industry.
(This abstract was borrowed from another version of this item.)
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Fama, Eugene F & French, Kenneth R, 1992. " The Cross-Section of Expected Stock Returns," Journal of Finance, American Finance Association, vol. 47(2), pages 427-465, June.
- Klepper, Steven & Leamer, Edward E, 1984. "Consistent Sets of Estimates for Regressions with Errors in All Variables," Econometrica, Econometric Society, vol. 52(1), pages 163-183, January.
- Cornelis A. Los, 2004.
"Optimal Multi-Currency Investment Strategies with Exact Attribution in Three Asian Countries,"
- Los, Cornelis A., 1998. "Optimal multi-currency investment strategies with exact attribution in three Asian countries," Journal of Multinational Financial Management, Elsevier, vol. 8(2-3), pages 169-198, September.
- Altman, Edward I. & Haldeman, Robert G. & Narayanan, P., 1977. "ZETATM analysis A new model to identify bankruptcy risk of corporations," Journal of Banking & Finance, Elsevier, vol. 1(1), pages 29-54, June.
- Zimmerman, David J, 1992. "Regression toward Mediocrity in Economic Stature," American Economic Review, American Economic Association, vol. 82(3), pages 409-429, June.
- Cornelis A. Los, 1991. "A Scientific View of Economic Data Analysis: Reply," Eastern Economic Journal, Eastern Economic Association, vol. 17(4), pages 526-531, Oct-Dec.
- William F. Sharpe, 1964. "Capital Asset Prices: A Theory Of Market Equilibrium Under Conditions Of Risk," Journal of Finance, American Finance Association, vol. 19(3), pages 425-442, 09.
- Harry Markowitz, 1952. "Portfolio Selection," Journal of Finance, American Finance Association, vol. 7(1), pages 77-91, 03.
- Cornelis A. Los, 1986. "Collinearity analysis of a simple money demand equation," Research Paper 8604, Federal Reserve Bank of New York.
- Ross, Stephen A., 1976. "The arbitrage theory of capital asset pricing," Journal of Economic Theory, Elsevier, vol. 13(3), pages 341-360, December.
- Chichilnisky, Graciela, 1996. "Markets with endogenous uncertainty: theory and policy," MPRA Paper 8612, University Library of Munich, Germany.
- William F. Sharpe, 1963. "A Simplified Model for Portfolio Analysis," Management Science, INFORMS, vol. 9(2), pages 277-293, January.
- Gary S. Becker, 1981. "A Treatise on the Family," NBER Books, National Bureau of Economic Research, Inc, number beck81-1.
- Magnus, J.R. & Morgan, M.S., 1995. "An experiment in applied econometrics," Other publications TiSEM a61c0907-aba4-4d79-9b0e-7, Tilburg University, School of Economics and Management.
- Cornelis A. Los, 1991. "A Scientific View of Economic Data Analysis," Eastern Economic Journal, Eastern Economic Association, vol. 17(1), pages 61-71, Jan-Mar.
- Harvey, Campbell R, 1991. " The World Price of Covariance Risk," Journal of Finance, American Finance Association, vol. 46(1), pages 111-157, March.
When requesting a correction, please mention this item's handle: RePEc:eee:jbfina:v:23:y:1999:i:12:p:1793-1829. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.