Cross-sectional alpha dispersion and performance evaluation

Campbell R. Harvey and Yan Liu

Journal of Financial Economics, 2019, vol. 134, issue 2, 273-296

Abstract: Our paper explores the link between cross-sectional fund return dispersion and performance evaluation. The foundation of our model is the simple intuition that in periods of high return dispersion, which is associated with high levels of idiosyncratic risk for zero-alpha funds, unskilled managers can more easily disguise themselves as skilled. Rational investors should be more skeptical and apply larger discounts to reported performance in high dispersion environments. Our empirical results are consistent with this prediction. Using fund flow data, we show that a one standard deviation increase in cross-sectional return dispersion is associated with an 11% to 17% decline in flow-performance sensitivity. The effect is stronger for recent data and among outperforming funds.

Keywords: Alpha; Hedge funds; Mutual funds; Performance evaluation; Bayesian; Appraisal ratio; Flow-performance sensitivity; Flow-performance convexity; Idiosyncratic risk; Performance ranks (search for similar items in EconPapers)
JEL-codes: G11 G14 G23 J24 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (16)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:134:y:2019:i:2:p:273-296

DOI: 10.1016/j.jfineco.2019.04.005

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