Class 9 Market Efficiency and Mutual Fund Performance

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Class 9 Market Efficiency and Mutual Fund Performance Evaluation

Class 9 Market Efficiency and Mutual Fund Performance Evaluation

Three Forms of Market Efficiency n n n Weak Form Efficiency: Can past price

Three Forms of Market Efficiency n n n Weak Form Efficiency: Can past price series be used to predict future excess returns? Semi-Strong Form Efficiency: Can publicly available information be used to predict future excess returns? Strong Form Efficiency: Can inside information be used to predict future excess returns?

High-Low-Close Chart

High-Low-Close Chart

Head and Shoulders Pattern Stock Price Time

Head and Shoulders Pattern Stock Price Time

Bollinger Bands IBM Bollinger Bands 110 105 100 Price ($) 95 90 85 80

Bollinger Bands IBM Bollinger Bands 110 105 100 Price ($) 95 90 85 80 75 70 12/31 02/19 04/09 05/29 07/18 09/06

Mutual Fund Styles n n n Aggressive Growth-Income-Growth Balanced Income

Mutual Fund Styles n n n Aggressive Growth-Income-Growth Balanced Income

Style and Beta Risk

Style and Beta Risk

Style and Volatility

Style and Volatility

Style and Average Returns

Style and Average Returns

Jensen’s Alpha n n From the CAPM: E[rit]-rf = bi(E[rmt]-rf). Any expectation can be

Jensen’s Alpha n n From the CAPM: E[rit]-rf = bi(E[rmt]-rf). Any expectation can be written as a realized value plus a shock: (rit+hit)-rf = bi({E[rmt]+hmt}-rf). Rearranging terms yields: rit -rf = bi(rmt-rf)+eit. Check intercept of the regression model: rit -rf = ai+bi(rmt-rf)+eit.

Historical Performance of Mutual Funds

Historical Performance of Mutual Funds

Distribution of Alphas

Distribution of Alphas

Distribution of t-Statistics

Distribution of t-Statistics

Portfolio Manager Ability n n Stock-picking ability: Can the manager identify which stocks will

Portfolio Manager Ability n n Stock-picking ability: Can the manager identify which stocks will outperform the market or the industry? Market-timing ability: Can the manager identify turning points between bull and bear markets?

Stock-Picking Ability

Stock-Picking Ability

Market-Timing Ability

Market-Timing Ability

Perfect Market-Timing Ability

Perfect Market-Timing Ability

Sharpe Ratios n n The Sharpe Ratio is the ratio of excess returns to

Sharpe Ratios n n The Sharpe Ratio is the ratio of excess returns to volatility: Compare the Sharpe Ratio for a particular fund to that of the market (or appropriate benchmark):

Ex-Post Sharpe Ratios

Ex-Post Sharpe Ratios

The Treynor Measure n n The Treynor Measure is the ratio of excess returns

The Treynor Measure n n The Treynor Measure is the ratio of excess returns to systematic risk: Compare the Yreynor Measure for a particular fund to that of the market (or appropriate benchmark):

Graham-Harvey Measures n n n Create a portfolio of S&P 500 futures contracts and

Graham-Harvey Measures n n n Create a portfolio of S&P 500 futures contracts and a money market account that matches the volatility of the particular mutual fund. Lever the mutual fund volatility to match the S&P 500 futures volatility by borrowing or lending. In each case, compare the returns of the two portfolios.

Graham-Harvey Measure

Graham-Harvey Measure

Performance Persistence

Performance Persistence

Investment Newsletter Performance n n n Graham and Harvey (1995) study the performance of

Investment Newsletter Performance n n n Graham and Harvey (1995) study the performance of recommendations of 200 investment newsletters. Given the evidence on market efficiency, what should we expect? Even if the newsletter writers have inside information - should we expect to make money by following their recommendations?

Performance of All Newsletters

Performance of All Newsletters

Performance of Long-Lived Newsletters

Performance of Long-Lived Newsletters

Ability to Time Bull Markets Monthly S&P 500 Return Performance of Newsletter Strategies Graham

Ability to Time Bull Markets Monthly S&P 500 Return Performance of Newsletter Strategies Graham and Harvey (1995) 20% 10% Fitted Regression Line 0% -10% -20% -30% 0% 10% 20% 30% 40% 50% 60% 70% Percent of letters which increased weights in each mo

Ability to Time Bear Markets

Ability to Time Bear Markets