Economic Optimism, Information Uncertainty and Future Investment Decisions: Evidence from the Mutual Fund Industry

Abstract:     
This paper studies the role of investors’ optimism about future economic growth in their investment decisions. Based on simple intuition, we argue that investors base their future investment decisions not only on asset-specific information, but also on their expectations about future economic growth. These expectations become particularly important to investors when they face hard-to-value assets with noisy and poor-quality asset-specific information. Consistent with this explanation, we find that investors’ investment decisions, as measured by mutual fund flows, are positively related to their economic optimism, even after accounting for various fund characteristics and macroeconomic conditions. Moreover, this effect is more pronounced for funds with greater fund-specific information uncertainty, i.e. funds that are small, belong to smaller fund families, or have highly volatile past performance. Our results suggest that investors not only consider forward-looking economic optimism in their investment decisions, but also put greater weight on it when fund-specific information seems uninformative and less valuable.

Number of Pages in PDF File: 43

Keywords: Investment Decisions, Economic Optimism, Information Uncertainty, Mutual Fund Flows

JEL Classification: E30, E32, G10, G11, G20, G23

working papers series