Pedigree Vs.

Grit
Predicting Mutual Funds Performance

Data, Analytics and Learning - Assignment 1

Submitted by Submitted to
Mukundapokhrel Y Bhuvanesh Pareek
7/13/2017
1. (a) Why do you disagree with Jack’s comments about the uselessness of the regression
due to the low R-squared?
R-squared cannot determine whether the coefficient estimates and predictions are
biased, which is why you must assess the residual plots. R-squared does not indicate whether a
regression model is adequate. You can have a low R-squared value for a good model, or a high
R-squared value for a model that does not fit the data.

(b) Can you think of a situation in which a useless regression has a high R-squared?
There might be situation when there is no logical relationship between two variables but with
high R-squared value. For example, no of professors in a college and no of customers visiting
a big bazaar shopping might get a R-squared value of 95% but logically the regression is
useless.

(c) There are techniques to determine the validity of a regression model—in particular,
whether the relationship is linear and the error terms display equal variance
(homoskedasticity). Does the regression in Table 1 violate either of these two
assumptions? Justify your answer.
Homoskedasticity seems to be absent in this case.

Jack is soon convinced that a low R-squared doesn’t render his regression useless, and
begins bombarding you with questions. Use Table 1 to answer questions 2 through 6.

2. (a) Estimate the excess return (RET) of the funds that Bob and Putney currently
manage. Assume that Princeton’s average composite SAT score is 1355, while Ohio
State’s is 1042. Between Bob and Putney, who is expected to obtain higher returns at their
current funds and by how much?
RET CONSTANT GRI SAT MBA AGE TEN
Coefficient -2.64216 -2.11046 0.005735 -0.18065 -0.06889 -0.11872
Bob -1.78162 1 1042 0 35 5
Putney 0.395635 1 1355 1 32 2

Between Bob and Putney, Putney is expected to obtain higher returns. Holding an MBA degree
has a significance of 81.139% which is way higher than the significance of other variables.

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(b) Between Bob and Putney, who is expected to obtain higher returns if hired by
AMBTPM and by how much?

This means RET at Zero Tenure,

Bob growth and income fund return at AMBTPM = -1.18820057515122%

Putney growth and income fund return = 0.632821651794345%

Thus Putney will always get higher returns than Bob at AMBTPM

3. (a) Can you prove at the 5 percent significance level that if Bob had attended Princeton
instead of Ohio State, then the return of his current fund would be greater?
As the coefficient of SAT is positive (0.005735) and since it is positively correlated, attending
Princeton instead of Ohio State will increase the return of Bob.

(b) Can you prove at the 10 percent level of significance that if Bob were managing a
growth fund instead of a growth and income fund, then he would achieve at least 1 percent
higher average returns?
The coefficient of GRI (-2.11046) is negatively correlated with the return. Thus if he was
managing growth fund, he would have achieved a higher return.

4. (a) Does the regression in Table 1 provide strong evidence for the claim that fund
managers with MBAs perform worse than managers without MBAs? What is being held
constant in this comparison? Discuss.
The regression in Table 1 shows that coefficient of MBA is negative and p value is 81.139%.
But there is no other evidence which shows that a person with MBA will perform better than
someone without a MBA.

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 Keeping the other factors such as GRI, SAT, AGE and TEN constant,
RET = Intercept + Coefficient of MBA = 2.642159 + (-0.180647) = -2.822806

(b) It has been suggested that fund managers without MBAs get higher expected returns
because they invest in riskier stocks. If this were true, what effect would including an
independent variable, Beta (with higher values corresponding to higher levels of
systematic risk in the fund’s portfolio), have on the coefficient of MBA in the regression
of Table 1?
There is an inverse relationship exists between Beta and the coefficient of MBA. Without
including Beta, MBA has a negative coefficient of -0.180647. Introducing Beta will increase
the value of the coefficient of MBA to positive due to negative correlation.
5. (a) What is the lowest level of significance at which you can prove that the manager’s
age has a negative impact on his or her fund’s performance holding the type of the fund,
the manager’s education, and years of experience at the fund constant?
Keeping the factors such as education, tenure, age constant, the lowest significance level at
which the manager’s age has a negative impact on fund’s performance is 99.9%

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(b) A survivorship bias is thought to be present in analyzing fund manager performance
in which a younger manager’s survival in the industry is more closely linked to his/her
performance than an older manager’s survival. In other words, if a new manager does
not perform successfully, he or she is not tolerated in the industry for long, but a
more experienced manager may be forgiven a year or two of poor performance. Would
the presence of this survivorship bias dampen or exacerbate the effect seen in Part (a)?

The regression analysis shows that, RET has negative correlation with AGE, positive
correlation with AGE^2 and negative correlation with AGE^3. As per survivorship bias, RET
will be low for young managers, higher for old managers and it will slightly decrease for very
old managers.

6. (a) “Streamline” the regression given in Table 1, that is, eliminate all variables that are
not significant at the 15 percent level. Write down the new regression equation and check
whether the specification satisfies the assumptions of linearity and homoskedasticity.

New regression equation will be

RET = -2.583922-2.111005 GRI + 0.006242 SAT - 0.095959 AGE
This regression model failed to satisfy the test of linearity and equal variances.

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(b) Compare the coefficient of AGE in the new and the old regressions. What can explain
the sign (direction) of the change in this estimator? Discuss.
Coefficient of AGE:
Old regression: -0.068893
new regression: -0.095959

Returns of fund managers are less for the new regression compared to the old regression
model.