A study of idiosyncratic volatility in mutual fund performance
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2014-05
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University of Hawaii at Manoa
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This research examines idiosyncratic volatility in mutual fund performance. It has two chapters. In the first chapter, we explore how fund managers have historically invested in stocks with different idiosyncratic volatilities and whether the idiosyncratic volatility of assets in a mutual fund portfolio is correlated with the funds performance. We find that mutual funds underweight stocks with the highest and lowest idiosyncratic volatilities; on average, loadings on high idiosyncratic volatility stocks tend to lower fund performance; and there is no evidence that actively managed funds exploit and profit from the negative relationship between idiosyncratic volatility and stock returns reported in prior studies. In the second chapter, we present "Residual Correlation" as a unifying measure of mutual fund active management. By decomposing portfolio idiosyncratic volatility into variance and covariance terms, we construct our "Residual Correlation" measure. We propose that skillful fund managers will anticipate positive unsystematic return events. By exposing their portfolios to those events, their portfolios will show correlated returns that are independent of common risk factors. Therefore, active management should be revealed through these correlated asset returns. We show that our measure can identify active management as precisely as various other measures of active management and that it also does so among groups of funds where other measures cannot.
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Mutual funds--Management, Idiosyncratic volatility
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Theses for the degree of Doctor of Philosophy (University of Hawaii at Manoa). International Management.
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