Performance Measurement with Uncertain Risk Loadings
Francesco A. Franzoni
University of Lugano; Swiss Finance Institute
Martin C. Schmalz
The Stephen M. Ross School of Business at the University of Michigan
September 3, 2014
Swiss Finance Institute Research Paper No. 13-41
Ross School of Business Paper No. 1194
We develop a model in which rational investors allocate capital to projects with uncertain risk exposure. Investors learn the projects' quality from project cash flows, conditioning on the systematic risk-factor realization. We show that the signal-to-noise ratio is highest when risk-factor realizations are close to zero. As a result, investors redirect more resources across projects during “moderate” times than during times with more “extreme” risk-factor realizations. We measure the speed of capital reallocation between projects with the sensitivity of mutual fund flows to performance and find supporting evidence for the model's qualitative and quantitative predictions.
Number of Pages in PDF File: 53
Keywords: Bayesian learning, parameter uncertainty, mutual funds, flow-performance
JEL Classification: G00, G20working papers series
Date posted: May 13, 2013 ; Last revised: September 4, 2014
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