Capital Flows in Rational Markets
Francesco A. Franzoni
University of Lugano; Swiss Finance Institute
Martin C. Schmalz
University of Michigan - Stephen M. Ross School of Busines
December 7, 2013
Swiss Finance Institute Research Paper No. 13-41
Ross School of Business Paper No. 1194
We provide a rational model of capital allocation to projects with uncertain exposure to a systematic risk factor. We show that signal-to-noise ratios are highest when the factor realization is close to zero. As a result, investors redirect more resources across projects during these times. We measure the speed of capital reallocation with the sensitivity of mutual fund flows to performance and find supporting evidence for the model's nonlinear and linear predictions.
Number of Pages in PDF File: 66
Keywords: capital allocation, mutual funds, flow-performance
JEL Classification: G00, G20working papers series
Date posted: May 13, 2013 ; Last revised: February 7, 2014
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