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The Shrinkage Adjusted Sharpe Ratio: An Improved Method for Mutual Fund Selection

Roll, Richard and Levy, Moshe (2022) The Shrinkage Adjusted Sharpe Ratio: An Improved Method for Mutual Fund Selection. Social Science Working Paper, 1464. California Institute of Technology , Pasadena, CA. (Unpublished)

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Mutual fund selection is a notoriously difficult task, because past performance is a poor predictor of future performance. We propose a fund performance measure that incorporates a simple idea: shrinkage, in the sense of Bayes-James-Stein, should be applied to gross return parameters, but not to fees, which are known. The proposed Shrinkage Adjusted Sharpe ratio (SAS) substantially improves the prediction of out-of-sample performance relative to existing methods. The best prediction is obtained when fees are weighed 5 times heavier than sample returns.

Item Type:Report or Paper (Working Paper)
Group:Social Science Working Papers
Subject Keywords:Mutual funds, Sharpe ratio, shrinkage, management fees, investment performance, alpha
Series Name:Social Science Working Paper
Issue or Number:1464
Classification Code:JEL Code: G11
Record Number:CaltechAUTHORS:20220415-224757554
Persistent URL:
Usage Policy:No commercial reproduction, distribution, display or performance rights in this work are provided.
ID Code:114355
Deposited By: Kapauhi Stibbard
Deposited On:15 Apr 2022 23:28
Last Modified:15 Apr 2022 23:28

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