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Performance Evaluation and Attribution of Security Portfolios by Russ Wermers, Bernd R. Fischer

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Chapter 8

Multiple Fund Performance Evaluation: The False Discovery Rate Approach

Abstract

This chapter develops a simple technique that controls for “false discoveries”, or managed funds that exhibit significant alphas by luck alone. The approach presented precisely estimates the proportion of fund managers that are (1) unskilled, (2) zero-alpha, and (3) skilled, even with dependencies in cross-fund estimated alphas. In an application to U.S. domestic equity mutual funds, this approach shows that 75% of funds exhibit zero alphas (net of trading costs and other expenses), consistent with the Berk and Green (2004) equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. Finally, ...

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