Stale Prices and the Performance Evaluation of Mutual Funds

Abstract

Staleness in measured prices imparts a positive statistical bias and a negative dilution effect on mutual fund performance. First, evaluating performance with nonsynchronous data generates a spurious component of alpha. Second, stale prices create arbitrage opportunities for high-frequency traders whose trades dilute the portfolio returns and hence fund performance. Thus, this paper introduces a model that directly estimates these biases and evaluates fund performance net of these effects. Empirical tests of the model show that the statistical bias is small but the dilution effect is large and widespread in the fund industry. Overall, during the sample period, funds lose about 40 basis points in annual performance due to price staleness.

Keywords: Performance evaluation, stale pricing, timing arbitrage, flows

JEL Classification: G12, G14