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A Direct and Full-Information Estimation of the Distribution of Skill in the Mutual Fund Industry

Author

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  • Angie ANDRIKOGIANNOPOULOU

    (University of Geneva and Swiss Finance Institute)

  • Filippos PAPAKONSTANTINOU

    (Imperial College London)

Abstract

We propose a novel approach to estimating the cross-sectional distribution of skill in the mutual fund industry, the proportion of funds with zero, negative, and positive alpha, and the skill of individual funds. We model the distribution of skill with a point mass at zero and two components, one with negative and one with positive support, and we tackle model specification uncertainty. We find that the skill distribution is highly non-normal, exhibiting heavy tails and negative skewness, and that while 14% of funds generate positive alpha, 76% have negative alpha; these results yield significantly different asset allocation decisions than previous estimates. Furthermore, portfolios formed using our methodology outperform those formed using alternative methodologies.

Suggested Citation

  • Angie ANDRIKOGIANNOPOULOU & Filippos PAPAKONSTANTINOU, 2014. "A Direct and Full-Information Estimation of the Distribution of Skill in the Mutual Fund Industry," Swiss Finance Institute Research Paper Series 14-42, Swiss Finance Institute, revised Dec 2014.
    • Handle: RePEc:chf:rpseri:rp1442
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    More about this item

    Keywords

    Mutual Funds; Skill; Performance; Specification Uncertainty; Point Mass; Bayesian Estimation;
    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
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C52 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Model Evaluation, Validation, and Selection
    • C58 - Mathematical and Quantitative Methods - - Econometric Modeling - - - Financial Econometrics

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