Estimating the Dynamics of Mutual Fund Alphas and Betas

Abstract

Consider an economy in which the underlying security returns follow a linear factor model with constant coefficients. While portfolios that invest in these securities will, in general, have a linear factor structure, it will be one with time-varying coefficients. However, under certain assumptions regarding the portfolio's investment strategy, it is possible to estimate these time-varying alphas and betas. Importantly, this can be done without direct knowledge of either the portfolio manager's exact investment strategy or of the alphas and betas of the individual securities in which the portfolio invests. This paper develops and estimates a Kalman filter statistical model to track time-varying fund alphas and betas. Several tests indicate that relative to a rolling OLS model the Kalman filter model produces more accurate fund factor loadings both in and out of sample. This appears to be in large part due to the attempts of fund managers to time the market by varying their fund's risk exposure from period to period. Another advantage of the Kalman filter model is that the dynamic parameter estimates can be used to classify funds by their trading strategies and to determine the source of a fund's profits or losses. The tests in this paper indicate that the superior and inferior returns produced by some funds arise almost entirely from attempts at market timing rather than managerial selection ability. However, as other research in the area of mutual fund performance measurement have found, overall there appears to be little evidence that, in aggregate, fund investors earn superior returns.

Testing the CAPM for the Brazilian Stock Market Using Multivariate GARCH between 1995 and 2012

“…There is a fall in the average estimated betas when announced dividends and share repurchases, indicating fall in non-diversifiable risk. Mamaysky, Spiegel and Zhang (2008) use the Kalman Filter to estimate the trajectory of the betas of investment funds. The method is justified by the inability of the static model of capture the dynamics of the market, an important component of analysis by managers.…”

The procyclicality of hedge fund alpha and beta

“…This gap must be filled because the signification of these signs is partly a matter of interpretation. 11 For another approach to dynamize alphas and betas, see Giamouridis and Vrontos (2007), Mamaysky et al (2007Mamaysky et al ( , 2008. 12 Note that an increase in market volatility usually takes place during an economic contraction, when the volume of market transactions skyrockets.…”

Carry trades and the performance of currency hedge funds

“…Persistence in funds performance has been largely investigated in various contexts (see, inter alia, Lynch and Musto, 2003;Cohen et al, 2005;Mamaysky et al, 2008 and the references therein).…”