On the Fundamental Law of Active Portfolio Management: What Happens If Our Estimates Are Wrong?

摘要

The fundamental law of active portfolio management pioneered by Grinold [1989] provides profound insights on the value-creation process of managed funds. However, a key weakness of the law and its various extensions is that they ignore the estimation risk associated with the parameter inputs of the law. We show that the estimation errors have a substantial impact on the value-added of an actively managed portfolio, and they can easily destroy all the value promised by the law if they are not dealt with carefully.