Portfolio Performance Measurement: A No Arbitrage Bounds Approach

This paper presents a new method to examine the performance evaluation of mutual funds in incomplete markets. Based on the no arbitrage condition, we develop bounds on admissible performance measures. We suggest new ways of ranking mutual funds and provide a diagnostic instrument for evaluating the admissibility of candidate performance measures. Using monthly data from 1984 to 1997, we show that admissible performance measures of mutual funds can vary widely, supporting the casual observation that investors disagree on the value of mutual funds. In particular, we cannot rule out that a majority of mutual funds are given positive values by some investors. Moreover, we empirically demonstrate that potential inference errors embedded in existing parametric performance measures can be of important magnitude. JEL classification: G12; G23