A New Family of Equity Style Indices and Mutual Fund Performance: Do Liquidity and Idiosyncratic Risk Matter?

53 Pages Posted: 28 Sep 2008 Last revised: 15 Sep 2011

Date Written: September 15, 2011

Abstract

We propose and test novel multifactor models of daily mutual fund performance. To this aim, we set up equity style indices and derive risk factors, which nest the established Fama and French (1992) and Carhart (1997) factors. We add two additional risk factors, namely idiosyncratic risk and Amihud (2002) liquidity. Our sample contains 528 actively managed mutual funds with European stock market focus during 2002 to 2009. Model estimation reveals that - while market excess return and size appear significant for the cross-section of all funds - the remainder factors explain the performance of subsets of funds. About one third of the funds exhibit significant factor sensitivities not only with respect to valuation or momentum, but also with respect to liquidity or idiosyncratic risk. No single risk factor is dominated and hence our six factor model may serve as a valid performance benchmark. In a four factor model setting, the Carhart model and a model with valuation replaced by liquidity perform best. Our results remain stable under various robustness checks. We further document that managers on average prefer liquid stocks, show no aggregate idiosyncratic risk preference and deliver results that are consistent with equilibrium models of fund performance.

Keywords: asset pricing anomalies, risk factors, mutual fund performance, idiosyncratic risk, liquidity

JEL Classification: G11, G12

Suggested Citation

Wagner, Niklas F. and Winter, Elisabeth, A New Family of Equity Style Indices and Mutual Fund Performance: Do Liquidity and Idiosyncratic Risk Matter? (September 15, 2011). Available at SSRN: https://ssrn.com/abstract=1274618 or http://dx.doi.org/10.2139/ssrn.1274618

Niklas F. Wagner (Contact Author)

Passau University ( email )

Innstrasse 27
Passau, 94030
Germany

Elisabeth Winter

University of Passau ( email )

Innstrasse 27
Passau, 94030
Germany

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