Economic Policy Uncertainty and Learning: Theory and Evidence on Mutual Funds

Abstract

Using the mutual fund industry as a laboratory, we demonstrate theoretically and empirically that economic policy uncertainty an affect investment decisions through an information rather than real options channel. Specifically, we find that fund flow-performance sensitivity decreases in uncertainty and does so more strongly for funds with shorter track records. The evidence supports the predictions of our model, most notably that investor learning about manager ability weakens when uncertainty increases. The results have implications for inefficient capital allocation during periods of higher uncertainty due to the resultant sluggish learning process.

Keywords: uncertainty, policy, learning, flow-performance sensitivity

JEL Classification: D82, D83, D84, G11, G23, G28