TY - JOUR
T1 - Alphas in disguise
T2 - A new approach to uncovering them
AU - Chinthalapati, Venkata
AU - Mateus, Cesario
AU - Todorovic, Natasa
PY - 2017/7
Y1 - 2017/7
N2 - 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.
AB - 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.
KW - Carhart alpha adjustment
KW - non-zero benchmark alphas
KW - optimization algorithm
KW - performance evaluation
UR - http://www.scopus.com/inward/record.url?scp=85022334863&partnerID=8YFLogxK
U2 - 10.1002/ijfe.1581
DO - 10.1002/ijfe.1581
M3 - Journal article
AN - SCOPUS:85022334863
SN - 1076-9307
VL - 22
SP - 234
EP - 243
JO - International Journal of Finance and Economics
JF - International Journal of Finance and Economics
IS - 3
ER -