Heuristic Fund Allocation Decisions

47 Pages Posted: 15 Nov 2016 Last revised: 13 Feb 2020

See all articles by Indraneel Chakraborty

Indraneel Chakraborty

University of Miami

Alok Kumar

University of Miami - Miami Herbert Business School

Tobias Muhlhofer

University of Miami - Department of Finance

Ravi Sastry

University of Melbourne - Department of Finance

Date Written: February 12, 2020

Abstract

We demonstrate that fund investors employ a heuristic benchmark model to estimate alphas and allocate capital. This can result in observational equivalence to CAPM driven investment decisions. The benchmark estimator trades off bias against precision, accommodating finite sample constraints. The estimator does not require knowledge of the (unknown) true model. Under a diffuse prior on alpha, the benchmark estimator dominates factor model estimates by the MSE criterion in 88% of our sample. We derive a sufficient condition under which the benchmark estimator dominates, even when the true pricing model is known. Fund investors employ a sophisticated approach to capital allocation.

Keywords: heuristics, mutual fund flows, sector funds, sophistication, model uncertainty

JEL Classification: G11

Suggested Citation

Chakraborty, Indraneel and Kumar, Alok and Muhlhofer, Tobias and Sastry, Ravi, Heuristic Fund Allocation Decisions (February 12, 2020). 8th Miami Behavioral Finance Conference 2017, University of Miami Business School Research Paper No. 2869426, Available at SSRN: https://ssrn.com/abstract=2869426 or http://dx.doi.org/10.2139/ssrn.2869426

Indraneel Chakraborty

University of Miami ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States
312-208-1283 (Phone)

HOME PAGE: http://sites.google.com/site/chakraborty/

Alok Kumar

University of Miami - Miami Herbert Business School ( email )

514 Jenkins Building
Department of Finance
Coral Gables, FL 33124-6552
United States
305-284-1882 (Phone)

HOME PAGE: http://moya.bus.miami.edu/~akumar

Tobias Muhlhofer (Contact Author)

University of Miami - Department of Finance ( email )

P.O. Box 248094
Coral Gables, FL 33124-6552
United States

HOME PAGE: http://tobias.muhlhofer.com

Ravi Sastry

University of Melbourne - Department of Finance ( email )

Level 12
198 Berkeley Street
Victoria 3010
Australia

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