The Cross-Section of Investing Skill

• Main Author: Sastry, Ravindra Vadali
• Language: English
• Published: 2012
• Subjects: Finance
• Online Access: https://doi.org/10.7916/D8RX9K5V

Building on insights from the economics of superstars, I develop an efficient method for estimating the skill of mutual fund managers. Outliers are especially helpful for disentangling skill from luck when I explicitly model the cross-sectional distribution of managerial skill using a flexible and realistic function. Forecasted performance is dramatically improved relative to standard regression estimates: an investor selecting (avoiding) the best (worst) decile of funds would improve risk-adjusted performance by 2% (3%) annually. The distribution of skill is found to be fat-tailed and positively skewed, providing a theoretical explanation for the convexity of fund flows.