Risk Shifting and Mutual Fund Performance
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"Risk Shifting and Mutual Fund Perfo..." refers methods in this paper
...To adjust for risk and style effects, abnormal returns are computed using the one-factor CAPM, the Fama and French (1993), the Carhart (1997), and the Ferson and Schadt (1996) models....
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"Risk Shifting and Mutual Fund Perfo..." refers background or methods in this paper
...The idiosyncratic volatilities are computed as the standard deviations of the residuals from the CAPM or the Carhart factor regressions over the prior 36 months. Portfolio 1 (5) includes funds that decrease (increase) their idiosyncratic risk by more than 2% per year and Portfolio 3 includes funds that change their idiosyncratic risk by less than 1%. We find a strong relation between risk shifting and fund performance for portfolios sorted according to changes in idiosyncratic volatilities, but do not find a statistically significant return pattern for portfolios sorted according to changes in systematic risk. For example, the performance difference between funds that increase their idiosyncratic risk the most (in Portfolio 5) and funds that maintain stable risk levels (in Portfolio 3) is between -18 and -21 basis points per month, both significant at the 5% level, depending on whether idiosyncratic risk is measured relative to the market model or the four-factor Carhart model. On the other hand, the performance difference between funds that increase their systematic risk the most and funds that maintain stable systematic risk is -5 basis points per month and is not statistically significant. Thus, the poor performance of funds that increase risk is driven by the increase in their idiosyncratic risk levels and not by the increase in their systematic risk exposure. Our results suggest that the main driver of the poor performance of risk shifters is not their inability to time the aggregate market movements but their tendency to take on idiosyncratic risk.(12) (12)Ang, Hodrick, Xing, and Zhang (2006) report that stocks with high idiosyncratic volatility based on daily returns tend to exhibit relatively poor abnormal returns in the subsequent month....
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...For example, high-expense funds in Portfolio 5 exhibit a Carhart alpha of -24 basis points per month, which is statistically significant at the 1% level, whereas low-expense funds in Portfolio 5 have an insignificant alpha of -10 basis points per month. The performance difference between high- and low-expense risk shifters (at 14 basis points per month) is substantially higher than the performance difference between all high- and low-expense funds (at only 3 basis points per month). Chevalier and Ellison (1997) find that younger funds with less established track records have a more convex flow-performance relation. Thus, younger mutual funds might have bigger incentives to shift risk. Similarly, smaller fund families also have more significant incentives to shift risk, as discussed in Huang, Wei, and Yan (2007). Panels B and C of Table 7 confirm that young funds and small fund families are more likely to shift risk and they experience particularly poor abnormal returns if they increase their risk levels....
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...The Fama-French-Carhart model nests the CAPM model (which includes only the market factor) and the Fama-French model (which includes the size and the book-to-market factors in addition to the market factor)....
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...To adjust for risk and style effects, abnormal returns are computed using the one-factor CAPM, the Fama and French (1993), the Carhart (1997), and the Ferson and Schadt (1996) models....
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...The first group of columns in Table 7 summarizes the frequency distribution of funds across the two groups and the last group of columns reports the subsequent Carhart alphas for the ten mutual fund portfolios.(13) Gil-Bazo and Ruiz-Verdu (2009) find that high-expense funds do not perform better than low-expense funds, even before subtracting expenses....
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