Do Stock-Level Experienced Returns Affect Security Selection?
45 Pages Posted: 10 Feb 2018 Last revised: 11 May 2021
Date Written: July 24, 2018
We examine whether the managers of equity mutual funds exhibit reinforcement learning, investing more heavily in firms in which they previously experienced higher returns. The results reliably support this hypothesis. Experienced returns affect managers' re-balancing decisions in response to flows, and influence investments at the style level. Experienced returns do not affect the investments of index-tracking funds. When new managers come in a fund, their experiences with stocks in their old funds, influence the investments in these stocks by their new funds. Funds managed by managers who rely more on reinforcement learning, earn lower returns. Experienced returns, when aggregated across managers for each stock, predict lower stock returns. Overall, our evidence indicates that reinforcement learning affects the stock-specific return trades of portfolio managers, with important implications for fund performance and asset prices.
Keywords: Reinforcement Learning, Decision from Experience, Mutual Funds, Behavioral Finance
JEL Classification: G11, G23, G40
Suggested Citation: Suggested Citation