Fund Choice Behavior and Estimation of Switching Models: An Experiment

Abstract

We run a laboratory experiment that contributes to the finance literature on "return chasing behavior" studying how investors switch between mutual funds driven by past performance of the funds. The subjects in this experiment make discrete choices between several (2, 3 or 4) experimental funds in multiple periods. The time series of funds' profits are exogenously generated prior to the experiment and subjects are paid for that period according to the profit of the fund they choose. The experimental results show that the investment decision can to a large extent be explained by a discrete choice model ("switching model") with a few lags and a predisposition effect. The intensity of choice parameter/beta in the discrete choice model depends on the structure of the profit time series of the funds, and there is no evidence that it is influenced by experience.

Keywords: switching, discrete choice model, mutual fund, experimental economics, intensity of choice

JEL Classification: C25, C91, D83, G11