Poker is a game of skill: is mutual fund management?
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LUCK VS SKILL IN MUTUAL FUND MANAGEMENT
This week, two fun Econ-Finance papers, both with a Chicago link.
First is Steven Levitt and Thomas Miles‘ analysis of whether poker is a game of skill:
Using newly available data, we analyze that question by examining the performance in the 2010 World Series of Poker of a group of poker players identified as being highly skilled prior to the start of the events. Those players identified a priori as being highly skilled achieved an average return on investment of over 30 percent, compared to a -15 percent for all other players. This large gap in returns is strong evidence in support of the idea that poker is a game of skill
It is a game of skill, they conclude. Read more here.
Next the famous Fama–French duo ask the same question of mutual fund management. They find [drumroll] there is a bit of evidence for skill (and its opposite) in the extreme tails of the distribution:
The aggregate portfolio of actively managed U.S. equity mutual funds is close to the market portfolio, but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations suggest that few funds produce benchmark-adjusted expected returns sufficient to cover their costs. If we add back the costs in fund expense ratios, there is evidence of inferior and superior performance (nonzero true α) in the extreme tails of the cross-section of mutual fund α estimates.
However, they wouldn’t advise trying to find a top manager over passive indexing:
In other words, going forward we expect that a portfolio of low cost index funds will perform about as well as a portfolio of the top three percentiles of past active winners, and better than the rest of the active fund universe.
REFERENCES
Levitt Steven D. and Thomas J. Miles. (2011). The Role of Skill Versus Luck in Poker: Evidence from the World Series of Poker, NBER Working Paper No. 17023. [link]
Fama, Eugene, F. and Kenneth R. French (2010) Luck versus Skill in the Cross-Section of Mutual Fund Returns. The Journal of Finance, LXV(5). [link]
Photo credit: http://www.flickr.com/photos/vizzzual-dot-com/2655969483/
There are much more powerful ways of distinguishing skill from luck than the method that Fama and French used. See for instance Finding good active managers.
October 17, 2011 @ 4:11 am
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