When Is Stock Picking Likely to Be Successful? Evidence from Mutual Funds

Consistent with a costly arbitrage equilibrium in which arbitrage costs insulate
mispricing, this study finds that mutual fund managers have stock-picking
ability for stocks with high idiosyncratic volatility but not for stocks with
low idiosyncratic volatility. These findings suggest that fund managers and
other investors may want to pay special attention to
high-idiosyncratic-volatility stocks because they provide fertile ground for
stock picking. The study also finds that the stock-picking ability of the
average mutual fund manager declined after the extreme growth in the number of
both mutual funds and hedge funds in the late 1990s.