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Rethinking Performance Evaluation

Author

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  • Campbell R. Harvey
  • Yan Liu

Abstract

We show that the standard equation-by-equation OLS used in performance evaluation ignores information in the alpha population and leads to severely biased estimates for the alpha population. We propose a new framework that treats fund alphas as random effects. Our framework allows us to make inference on the alpha population while controlling for various sources of estimation risk. At the individual fund level, our method pools information from the entire alpha distribution to make density forecast for the fund's alpha, offering a new way to think about performance evaluation. In simulations, we show that our method generates parameter estimates that universally dominate the OLS estimates, both at the population and at the individual fund level. While it is generally accepted that few if any mutual funds outperform, we find that the fraction of funds that generate positive alphas is accurately estimated at over 10%. An out-of-sample forecasting exercise also shows that our method generates superior alpha forecasts.

Suggested Citation

  • Campbell R. Harvey & Yan Liu, 2016. "Rethinking Performance Evaluation," NBER Working Papers 22134, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:22134
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    Cited by:

    1. Hamid Reza Mohammadi Ojan & Mohammad Karimi & Ebrahim Kardgar & Mehdi Ahrari, 2018. "The Extraction of Influencing Indicators for Scoring of Insurance Companies Branches Based on GMDH Neural Network," Iranian Economic Review (IER), Faculty of Economics,University of Tehran.Tehran,Iran, vol. 22(2), pages 527-556, Spring.
    2. Grønborg, Niels S. & Lunde, Asger & Timmermann, Allan & Wermers, Russ, 2021. "Picking funds with confidence," Journal of Financial Economics, Elsevier, vol. 139(1), pages 1-28.
    3. Naveed Ahmad Khan & Andrija Mihoci & Silke Michalk & Kirill Sarachuk & Hafiz Ali Javed, 2022. "Employee Performance Measures Appraised by Training and Labor Market: Evidence from the Banking Sector of Germany," Administrative Sciences, MDPI, vol. 12(4), pages 1-13, October.
    4. James W. Kolari & Jianhua Z. Huang & Wei Liu & Huiling Liao, 2022. "Further Tests of the ZCAPM Asset Pricing Model," JRFM, MDPI, vol. 15(3), pages 1-23, March.

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    More about this item

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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