43 Pages Posted: 9 Jul 2014 Last revised: 27 Oct 2016
Date Written: October 26, 2016
Mutual funds’ flows are sensitive to their star ratings. Such so-called “star-rating effects” are usually attributed to investors' attention, treated as exogenous to funds’ future performance, and thus used to identify the causal effects of funds’ sizes on their performance. In this paper, however, we show that in equilibrium, star ratings affect funds’ incentives to acquire information. Specifically, when a fund has just been upgraded to a higher star group, its incentives have a discrete jump, and so does its expected performance. Investors anticipate such an effect and invest more. Therefore, the star-rating effects are correlated to funds’ future performance.
Keywords: Mutual Fund, Reputation, Information Superiority, Information Acquisition, Obsolete Information, Morningstar
JEL Classification: C73, D83, G23
Suggested Citation: Suggested Citation
Huang, Chong and Li, Fei and Weng, Xi, Star-rating Effects and the Incentives of Mutual Funds (October 26, 2016). Available at SSRN: https://ssrn.com/abstract=2463364 or http://dx.doi.org/10.2139/ssrn.2463364