Are Professional Investors Prone to Behavioral Biases? Evidence from Mutual Fund Managers

Abstract

I study the determinants of mutual fund managers’ expectations about the stock market and its implications for decision making and fund performance. Using a direct measure of managers’ market expectations extracted from mutual funds’ semi-annual reports, I find that fund managers extrapolate their funds’ past performance into their market outlook. In addition, their expectation about the market return is negatively related to whether they experienced the burst of the dot-com bubble. Funds with managers who have higher market expectation take more risk by increasing their equity holdings and the beta of their equity portfolios, but underperform subsequently. My results suggest that professional investors are also prone to behavioral biases, which is detrimental to mutual fund investors.

Keywords: Mutual Funds, Behavioral Finance, Return Extrapolation, Return Expectations, Risk-Taking, Asset Allocation

JEL Classification: G01, G11, G23, G4