Bayesian Alphas and Mutual Fund Persistence

Bayesian Alphas and Mutual Fund Persistence
Author(s): Busse, Jeffrey and Irvine, Paul J.
Year: 2005
Paper Number: GBS-ACC-2005-018
Goizueta Department: Accounting

Abstract

We use daily returns to contrast the performance predictability of Bayesian estimates of mutual fund performance with standard frequentist measures. When the returns on passive nonbenchmark assets are correlated with fund holdings, incorporating histories of these returns produces a performance measure that predicts future performance better than standard measures. Bayesian alphas based on the CAPM are particularly useful for predicting future standard CAPM alphas. Over our sample period, priors consistent with moderate to diffuse beliefs in managerial skill dominate more skeptical prior beliefs, a result that is consistent with investor cash flows.