Fragile Factor Premia
54 Pages Posted: 20 Jan 2019 Last revised: 10 Jun 2020
Date Written: January 9, 2019
We demonstrate that returns and volatilities of the Fama-French size and value factors are significantly determined by non-fundamental flow-induced trading from actively managed equity mutual funds. Mutual fund flows are largely ignorant about systematic risks. These non-fundamental shifts in demand induce large return heterogeneity within and across the Fama-French size and book-to-market portfolios. We show that aggregate mutual fund flow- induced trades across the size and book-to-market spectrum significantly influence the size and value premia, followed by large subsequent reversals. We also find that the expected volatilities of mutual funds’ flow-induced trades strongly predict future factor volatilities. Our results highlight the importance of non-fundamental demand shocks in determining factor premia and factor volatilities.
Keywords: Mutual fund flows, factor premia, factor volatility
JEL Classification: G10
Suggested Citation: Suggested Citation