False Discoveries in Exchange-Traded Fund Performances: Identifying ETFs that outperform the market

Abstract

Compared to the traditional mutual funds, an exchange-traded fund (ETF) is very similar, yet different in its nature as an investment fund traded on stock exchanges, much like stocks. In this paper, we will follow an existing metric that precisely separates funds into (1) underperforming, (2) zero-alpha, and (3) outperforming the market, and apply a new methodology based on principal factor approximation, which successfully subtracts the common dependence and weakens significantly the correlation structure, to deal with any arbitrary covariance dependence in cross-fund estimated alphas. There will not be direct comparison for the two methods, but we will exhibit the results we have identified from both methods, and try to identify the ETFs that truly exhibit significant alphas.