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This is a blogpost by a Professor of Finance from NYU Stern
A hedge fund manager doubles her investors' money over the course of a year.. A company's stock increases four fold over the course of six months.... these are not unusual news stories but they give rise to one of those enduring questions in finance: Was it luck or skill? The answer of course is critical. If it was "luck", we should not be giving the hedge fund manager 2% of our wealth and 20% of the profits. If it was skill, the company's managers deserve not just a huge thank you but commensurate financial rewards.
As always in finance, there are two extreme outlooks. At one end, there are those who view any superior performance as evidence of skill and extended superior performance as almost super natural. At the other end, there are those who who contend that it is all "luck" and that portfolio managers have any "discernible skill". As an illustration, Fama and French have a damning article on active portfolio management, where they note that all of the excess returns in practice can be explained by randomness:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021
In their assessment, all "superior performance" in portfolio management can be attributed to luck. Here is a more recent paper by Andrew Mauboussin and Sam Arbesman that argues that there is some evidence of differential skill:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1664031
Needless to say, this is an issue where researchers have disagreed and continue to do so.
See more http://aswathdamodaran.blogspot.com/2011/03/luck-versus-skill-how-can-you-tell.html
A hedge fund manager doubles her investors' money over the course of a year.. A company's stock increases four fold over the course of six months.... these are not unusual news stories but they give rise to one of those enduring questions in finance: Was it luck or skill? The answer of course is critical. If it was "luck", we should not be giving the hedge fund manager 2% of our wealth and 20% of the profits. If it was skill, the company's managers deserve not just a huge thank you but commensurate financial rewards.
As always in finance, there are two extreme outlooks. At one end, there are those who view any superior performance as evidence of skill and extended superior performance as almost super natural. At the other end, there are those who who contend that it is all "luck" and that portfolio managers have any "discernible skill". As an illustration, Fama and French have a damning article on active portfolio management, where they note that all of the excess returns in practice can be explained by randomness:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021
In their assessment, all "superior performance" in portfolio management can be attributed to luck. Here is a more recent paper by Andrew Mauboussin and Sam Arbesman that argues that there is some evidence of differential skill:
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1664031
Needless to say, this is an issue where researchers have disagreed and continue to do so.
See more http://aswathdamodaran.blogspot.com/2011/03/luck-versus-skill-how-can-you-tell.html
