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Rational Cross-Sectional Differences in Market Efficiency: Evidence from Mutual Fund Returns

Published online by Cambridge University Press:  02 July 2010

Paul Schultz
Paul Schultz*
Affiliation:
University of Notre Dame, 260 Mendoza College of Business, Notre Dame, IN 46556. schultz.19@nd.edu
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Abstract

Markets should be inefficient enough to allow returns to security analysis to adequately compensate the marginal analyst for his efforts. Cross-sectional differences in the costs of analysis therefore imply cross-sectional differences in market efficiency and in before-cost returns to smart investors. Small growth stocks are difficult to analyze and costly to trade. I find that the abnormal returns of mutual fund investments in small growth stocks from 1980 to 2006 averaged 0.76% per month. Large value stocks are easier to analyze and cheaper to trade. Mutual funds earned average monthly abnormal returns of only 0.05% in large value stocks during the same period.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 4 , August 2010 , pp. 847 - 881
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

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