Constructing and Using Double-adjusted Alphas to Analyze Mutual Fund Performance

Erik Kole () and Reza Brink
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Reza Brink: Erasmus Universiteit Rotterdam

No 19-029/IV, Tinbergen Institute Discussion Papers from Tinbergen Institute

Abstract: We propose a new approach for estimating mutual fund performance controlling for both factor exposure and characteristics. Motivated factor models’ failure to fully adjust returns for anomalies, our hierarchical Bayesian model separates the true alpha from the effect of stock characteristics. It is straightforward and improves the traditional two-pass estimation. Our double-adjusted alphas produce a different ranking of mutual funds than the traditional alphas. Consequently, evidence of persistence in performance increases, the link between selectivity and alpha disappears, but fund flows are related to the true alpha and not to characteristics. Concludingly, measuring true outperformance is crucial for understanding skill.

Keywords: Mutual fund performance; Double-adjusted performance; Firm characteristics; Hierarchical Bayes (search for similar items in EconPapers)
JEL-codes: C11 G11 G23 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-fmk
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Persistent link: https://EconPapers.repec.org/RePEc:tin:wpaper:20190029

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