False Discoveries in Mutual Fund Performance: Measuring Luck in Estimated Alphas





    Search for more papers by this author
    • Barras is at the Desautels Faculty of Management at McGill University, Scaillet is at the Swiss Finance Institute at HEC-University of Geneva, and Wermers is at the Robert H. Smith School of Business at the University of Maryland at College Park. We thank Stephen Brown, Bernard Dumas, Amit Goyal, Mark Grinblatt, Mark Huson, Andrew Metrick, Lars Pedersen, Elvezio Ronchetti, René Stulz, Sheridan Titman, Maria-Pia Victoria-Feser, and Michael Wolf, as well as seminar participants at Banque Cantonale de Genève, BNP Paribas, Bilgi University, CREST, Greqam, Imperial College, INSEAD, London School of Economics, Maastricht University, MIT, Princeton University, Queen Mary, Solvay Business School, NYU (Stern School), UBP Geneva, Universita della Svizzera Italiana, University of Geneva, University of Georgia, University of Indiana, University of Missouri, University of Notre-Dame, University of Pennsylvania, Vienna University of Economics and Business Administration, University of Virginia (Darden), the Swiss Doctoral Workshop (2005), the Research and Knowledge Transfer Conference (2006), the Zeuthen Financial Econometrics Workshop (2006), the Professional Asset Management Conference at RSM Erasmus University (2008), the Joint University of Alberta/Calgary Finance Conference (2008), the 2005 European Conference of the Econom[etr]ics Community, 2006 Econometric Society European Meeting, 2006 European Conference on Operational Research, 2006 International Congress of Actuaries, 2006 French Finance Association Meeting, 2006 Swiss Society for Financial Market Research Meeting, and 2007 Campus for Finance Meeting (Otto Beisheim School of Management) for their comments. We are also grateful to Campbell Harvey (the editor), an associate editor, and the referee (anonymous) for numerous helpful insights. This paper won the 2008 Banque Privée Espírito Santo Prize for best paper of the Swiss Finance Institute. The first and second authors acknowledge financial support by the National Centre of Competence in Research “Financial Valuation and Risk Management” (NCCR FINRISK). Part of this research was done while the second author was visiting the Centre Emile Bernheim (ULB).


This paper develops a simple technique that controls for “false discoveries,” or mutual funds that exhibit significant alphas by luck alone. Our approach precisely separates funds into (1) unskilled, (2) zero-alpha, and (3) skilled funds, even with dependencies in cross-fund estimated alphas. We find that 75% of funds exhibit zero alpha (net of expenses), consistent with the Berk and Green equilibrium. Further, we find a significant proportion of skilled (positive alpha) funds prior to 1996, but almost none by 2006. We also show that controlling for false discoveries substantially improves the ability to find the few funds with persistent performance.