The predictive ability of the expected utility-entropy based fund rating approach: A comparison investigation with Morningstar ratings in US.

Abstract

In this paper, we propose an alternative fund rating approach based on the Expected Utility-Entropy (EU-E) decision model, in which the measure of risk for a risky action was axiomatically developed by Luce et al. We examine the ability of this approach as an alternative fund rating approach for its ability to potentially mitigate the drawbacks of the risk measure used in Morningstar ratings, and investigate the ability of the EU-E model based and Morningstar ratings to predict mutual fund performance. Overall, we find that the risk measure used in both models plays a defining role in their ability to predict future fund performance, and that the EU-E model can effectively consider the behavioral decisions of an investor.