Jennifer N. Carpenter and Anthony W. Lynch
ABSTRACT
We generate samples of fund returns calibrated to match the U.S. mutual
fund
industry and simulate standard tests of performance persistence.
We consider a variety of alternative return generating processes, survival
criteria, and test methodologies. When survival depends on performance
over
several periods, survivorship bias induces spurious reversals, despite the
presence of cross-sectional heteroskedasticity in performance. In samples
which are largely free of survivorship bias, look-ahead biased
methodologies
and missing returns still affect statistics. In samples with no true
persistence, the spurious persistence caused by survivorship bias in the
presence of single-period survival criteria never reaches the magnitude
found in recent empirical studies. When fund returns are truly
persistent,
the simulations reveal an attrition effect, distinct from survivorship
bias.
The systematic disappearance of poor performers causes mean persistence
measures to differ from those in a hypothetical sample in which funds
never
disappear, even in tests which incorporate all data on disappearing funds.
The magnitude and direction of this effect depends on the return
generating
process. We also examine the specification and power of the persistence
tests. The t-test for the difference between top and bottom portfolios
ranked by past performance is the best specified under the null and among
the most powerful against the alternatives we consider.
Carpenter: jcarpen0@stern.nyu.edu
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