Limits to mutual funds' ability to rely on mean/variance optimization

Iordanis Karagiannidis and Nadia Vozlyublennaia

Journal of Empirical Finance, 2016, vol. 37, issue C, 282-292

Abstract: Our evidence suggests that estimation error in the required statistics is an important factor inhibiting investors' ability to rely on mean/variance analysis. We compare the returns reported by mutual funds to the returns obtained from a mean/variance optimized portfolio of fund holdings. The results suggest that funds tend to outperform the optimized portfolio out-of-sample (when means/variances/covariances are unknown), but under-perform in-sample (when the required statistics in the optimization are known). Therefore, a popular assumption in asset pricing models that investors rely on a basic mean/variance analysis with known underlying statistics is likely to be grossly violated in the case of mutual funds.

Keywords: Estimation risk; Portfolio optimization; Mutual funds (search for similar items in EconPapers)
JEL-codes: G10 G11 G23 (search for similar items in EconPapers)
Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:eee:empfin:v:37:y:2016:i:c:p:282-292

DOI: 10.1016/j.jempfin.2016.01.008

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