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Reassessing False Discoveries in Mutual Fund Performance: Skill, Luck, or Lack of Power? A Reply

Author

Listed:
  • Laurent Barras

    (McGill University - Desautels Faculty of Management)

  • O. Scaillet

    (University of Geneva GSEM and GFRI; Swiss Finance Institute; University of Geneva - Research Center for Statistics)

  • Russ Wermers

    (University of Maryland - Robert H. Smith School of Business)

Abstract

Andrikogiannopoulou and Papakonstantinou (AP; 2019) conduct an inquiry into the bias of the False Discovery Rate (FDR) estimators of Barras, Scaillet, and Wermers (BSW; 2010). In this Reply, we replicate their results, then further explore the bias issue by (i) using different parameter values, and (ii) updating the sample period. Over the original period (1975-2006), we show how reasonable adjustments to the parameter choices made by BSW and AP results in a sizeable reduction in the bias relative to AP. Over the updated period (1975-2018), we further show that the performance of the FDR improves dramatically across a large range of parameter values. Specifically, we find that the probability of misclassifying a fund with a true alpha of 2% per year is 32% (versus 65% in AP). Our results, in combination with those of AP, indicate that the use of the FDR in finance should be accompanied by a careful evaluation of the underlying data generating process, especially when the sample size is small.

Suggested Citation

  • Laurent Barras & O. Scaillet & Russ Wermers, 2019. "Reassessing False Discoveries in Mutual Fund Performance: Skill, Luck, or Lack of Power? A Reply," Swiss Finance Institute Research Paper Series 19-61, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1961
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    Citations

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    Cited by:

    1. Campbell R. Harvey & Yan Liu, 2020. "False (and Missed) Discoveries in Financial Economics," Journal of Finance, American Finance Association, vol. 75(5), pages 2503-2553, October.
    2. Jing Zhang & Wei Zhang & Youwei Li & Xu Feng, 2022. "The role of hedge funds in the asset pricing: evidence from China," The European Journal of Finance, Taylor & Francis Journals, vol. 28(2), pages 219-243, January.
    3. Sermpinis, Georgios & Hassanniakalager, Arman & Stasinakis, Charalampos & Psaradellis, Ioannis, 2021. "Technical analysis profitability and Persistence: A discrete false discovery approach on MSCI indices," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 73(C).

    More about this item

    Keywords

    False Discovery Rate; Multiple Testing; Mutual Fund Performance;
    All these keywords.

    JEL classification:

    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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