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Reverse Survivorship Bias

Mutual funds often disappear following poor performance. When this poor performance is partly attributable to negative idiosyncratic shocks, funds' estimated alphas understate their true alphas. This paper estimates a structural model to correct for this bias. Although most funds still have neg...

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Bibliographic Details
Published in:The Journal of finance (New York) 2013-06, Vol.68 (3), p.789-813
Main Author: LINNAINMAA, JUHANI T.
Format: Article
Language:English
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Summary:Mutual funds often disappear following poor performance. When this poor performance is partly attributable to negative idiosyncratic shocks, funds' estimated alphas understate their true alphas. This paper estimates a structural model to correct for this bias. Although most funds still have negative alphas, they are not nearly as low as those suggested by the fund-by-fund regressions. Approximately 12% of funds have net four-factor model alphas greater than 2% per year. All studies that run fund-byfund regressions to draw inferences about the prevalence of skill among mutual fund managers are subject to reverse survivorship bias.
ISSN:0022-1082
1540-6261
DOI:10.1111/jofi.12030