NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Bayesian Performance Evaluation

Klaas Baks, Andrew Metrick, Jessica Wachter

NBER Working Paper No. 7069
Issued in April 1999
NBER Program(s):   AP

This paper proposes a Bayesian method of performance evaluation for investment managers. We begin with a flexible set of prior beliefs that can be elicited without any reference to probability distributions or their parameters. We then combine these prior beliefs with a general multi-factor model and derive an analytical solution for the posterior expectation of alpha', the intercept term from the model. This solution can be computed using only a few extra steps beyond maximum likelihood estimation and does not require a comprehensive or bias-free database. We then apply our methodology to a sample of domestic diversified equity mutual funds and ask what prior beliefs would imply zero investment in active managers?' To justify such a zero-investment strategy, we find that a mean-variance investor would need to believe that less than 1 out of every 100,000 managers has an expected alpha greater than 25 basis points per month. Overall, our analysis suggests that even when the average manager is expected to underperform passive benchmarks, it requires very strong prior beliefs to imply zero investment in managers with the best past performance.

download in pdf format
   (527 K)

email paper

This paper is available as PDF (527 K) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w7069

Published: Newly titled "Should Investors Avoid All Actively Managed Mutual Funds? A Study in Bayesian Performance Evaluation", Journal of Finance (February 2001).

Users who downloaded this paper also downloaded these:
Farnsworth, Ferson, Jackson, and Todd w8791 Performance Evaluation with Stochastic Discount Factors
Lewellen and Shanken w7699 Estimation Risk, Market Efficiency, and the Predictability of Returns
Stambaugh w5918 Analyzing Investments Whose Histories Differ in Length
Kane and Marks w2640 Performance Evaluation of Market Timers
Berk and Tonks w13042 Return Persistence and Fund Flows in the Worst Performing Mutual Funds
 
Publications
Activities
Meetings
Data
People
About

Support
National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email: info@nber.org

Contact Us