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Alphas in disguise: A new approach to uncovering them

Alphas in disguise: A new approach to uncovering them
Alphas in disguise: A new approach to uncovering them
Four‐factor Carhart alphas of passive indices should be zero, but recent empirical evidence shows otherwise. We propose an optimization algorithm that makes small (fixed) adjustments to the time series of the market, size, value, and momentum factors, which ensures a zero alpha for any (single) self‐designated benchmark index of a mutual fund. Our “adjusted factors” can then be used to estimate a mutual fund's “adjusted alpha.” We test this methodology on a sample of 1,281 active and 102 tracker U.S. equity mutual funds (reporting S&P 500 index as their prospectus benchmark). Our time series adjustment of the Carhart 4 factors leads to an increase (decrease) in a fund's “adjusted alpha” in periods of fund‐benchmark underperformance (outperformance). On the whole, our “adjusted alphas” of both active and tracker funds are statistically significantly negative. This is particularly pronounced for tracker funds.
1076-9307
234-243
Chinthalapati, Venkata
65ec749f-9695-4550-a408-93c649f807af
Mateus, Cesario
e05a0662-e701-4588-8f0f-0b959899636e
Todorovic, Natasa
6de01ac2-ccd9-4a38-ba92-7761f8e28f65
Chinthalapati, Venkata
65ec749f-9695-4550-a408-93c649f807af
Mateus, Cesario
e05a0662-e701-4588-8f0f-0b959899636e
Todorovic, Natasa
6de01ac2-ccd9-4a38-ba92-7761f8e28f65

Chinthalapati, Venkata, Mateus, Cesario and Todorovic, Natasa (2017) Alphas in disguise: A new approach to uncovering them. International Journal of Finance & Economics, 22 (3), 234-243. (doi:10.1002/ijfe.1581).

Record type: Article

Abstract

Four‐factor Carhart alphas of passive indices should be zero, but recent empirical evidence shows otherwise. We propose an optimization algorithm that makes small (fixed) adjustments to the time series of the market, size, value, and momentum factors, which ensures a zero alpha for any (single) self‐designated benchmark index of a mutual fund. Our “adjusted factors” can then be used to estimate a mutual fund's “adjusted alpha.” We test this methodology on a sample of 1,281 active and 102 tracker U.S. equity mutual funds (reporting S&P 500 index as their prospectus benchmark). Our time series adjustment of the Carhart 4 factors leads to an increase (decrease) in a fund's “adjusted alpha” in periods of fund‐benchmark underperformance (outperformance). On the whole, our “adjusted alphas” of both active and tracker funds are statistically significantly negative. This is particularly pronounced for tracker funds.

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More information

Accepted/In Press date: 21 June 2017
e-pub ahead of print date: 10 July 2017
Published date: July 2017

Identifiers

Local EPrints ID: 431407
URI: http://eprints.soton.ac.uk/id/eprint/431407
ISSN: 1076-9307
PURE UUID: 4b161335-f7e8-4625-bbdc-5b747f2329e4

Catalogue record

Date deposited: 31 May 2019 16:30
Last modified: 07 Aug 2019 16:30

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