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Discussion Paper Details

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Title: Expectations of Active Mutual Fund Performance

Author(s): Magnus Dahlquist, Markus Ibert and Felix Wilke

Publication Date: December 2020

Keyword(s): Alpha, Expectation Formation and Mutual funds

Programme Area(s): Financial Economics

Abstract: We recover a forward-looking distribution of expected abnormal returns (alphas) for active equity mutual funds from analyst ratings. Professional analysts believe that alphas are dispersed, that the average fund will underperform, and that the largest funds will outperform. We estimate a rational expectations learning model of fund performance and confront the model-implied expectations based on fund size, perceived skill, and fees with analysts' expectations. Analysts and the rational learner respond similarly to changes in perceived skill and fees, but in contrast to the rational learner, analysts do not believe in a negative impact of fund size on fund returns. The absence of such decreasing returns to scale in analysts' expectations and the presence thereof in actual fund returns make it difficult to reconcile analysts' expectations with rational expectations, but can help explain the size of the industry together with its poor performance.

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Bibliographic Reference

Dahlquist, M, Ibert, M and Wilke, F. 2020. 'Expectations of Active Mutual Fund Performance'. London, Centre for Economic Policy Research. https://cepr.org/active/publications/discussion_papers/dp.php?dpno=15548