Detecting mutual fund timing ability using the threshold model

Abstract

This paper proposes a new method based on threshold regression to test mutual fund market-timing abilities. The traditional Henriksson and Merton model is shown to represent only a special case within the proposed model. The potential bias of using the traditional model is demonstrated and it is argued that the proposed model provides more accurate inferences on the market-timing effects of mutual funds. The empirical results for a set of randomly-selected US mutual funds indicate the superior performance of the proposed method in detecting the market-timing ability.

Notes

¹ Treynor and Mazuy (1966), Henriksson and Merton (1981) and Chang and Lewellen (1984) noted that investment managers have superior information and forecasting skills.

² The results are omitted to save space. However, they are available upon request.

³ The regression results of the threshold effect from Equation 6 are omitted for saving space. Sixteen of the mutual funds exhibited a positive and significant value for , indicating that the fund manager has stock-selection ability based upon the threshold effect. Four of the mutual funds also exhibited a positive and significant value for , indicating that the fund manager has market-timing ability based upon the threshold effect.