Past Performance is Indicative of Future Beliefs
Gregg S. Fisher
April 11, 2011
Risk and Decision Analysis, Forthcoming
NYU Poly Research Paper
The performance of the average investor in an asset class lags the average performance of the asset class itself by an average of one percent per year over the past fifteen years, based on net investor mutual fund cash flows. We present a model in which a representative behavioral investor believes next year’s returns will exactly match last year’s returns and show that this leads to price adjustments on what would otherwise be random walk securities that effectively lower the future return of high performers and raise the future return of poor performers. The average predicted behavioral lag indeed matches the observed lag when asset returns are normally distributed with a mean and standard deviation equivalent to historical fifteen year averages of six percent and eighteen percent, respectively, and when the representative investor increases his allocation by 25 percent more than the return itself, a prediction for which we document empirical support. In other words, investors chase returns and in doing so create the conditions of their own demise.
Number of Pages in PDF File: 12
Keywords: behavioral, trading, mutual funds, momentum, investor returns
JEL Classification: G11, G14
Date posted: January 26, 2011 ; Last revised: April 29, 2011
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