When is Money Likely to Be Smart? Evidence from Mutual Fund Investors in Taiwan
Investment Analysts Journal, No. 73, pp. 13-25, 2011
34 Pages Posted: 27 Feb 2011 Last revised: 5 Jan 2015
Date Written: January 31, 2010
Past behavioral research has provided evidence that fund investors have the ability to predict fund performance, called the smart money effect. In this study we examine whether the smart money effect exists in the Taiwanese mutual fund market. Specifically, we investigate whether the smart money effect appears across UP and DOWN markets and whether this effect persists over time. Consistent with the literature, we find that the smart money effect exists over our sample period. Moreover, after categorizing the market states as either UP or DOWN markets, our evidence shows a significant smart money effect only following DOWN markets but not following UP markets. According to behavioral theories, bad market states evoke negative affective states in investors, so negatively affected investors may rely less on the use of heuristics and become more careful and logical in their investment decisions. This paper infers that the existence of a smart money effect after DOWN markets occurs because investors in negative emotional states are likely to use more detailed information processing in their decision-making.
Keywords: The Smart Money Effect, Behavioral Theory, Carhart Four-Factor Alpha, Market States
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