Mutual Fund Flows and Performance in (Imperfectly) Rational Markets?

62 Pages Posted: 9 Dec 2020 Last revised: 9 May 2022

See all articles by Nikolai L. Roussanov

Nikolai L. Roussanov

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Hongxun Ruan

Guanghua School of Management, Peking University

Yanhao 'Max' Wei

University of Southern California - Marshall School of Business

Date Written: May 5, 2020

Abstract

Does the observed relationship between mutual fund flows and recent performance represent irrational “return chasing” or rational learning about unobserved fund manager skill in the presence of decreasing returns to scale? We estimate a structural model of investor beliefs implicit in the fund flows and compare it with the rational Bayesian benchmark that estimated from past performance data. Our estimates imply that investors are more optimistic about fund manager’s average skill level than warranted by the historical data. They over-weight recent performance in a manner consistent with models based on the representativeness heuristic, yet respond slowly to changes in these beliefs, consistent with limited attention and/or informational frictions. Flows to retail funds imply more strongly biased beliefs than those to institutional funds.

Keywords: mutual fund performance, flow-performance relationship, Bayesian learning, representativeness

Suggested Citation

Roussanov, Nikolai L. and Ruan, Hongxun and Wei, Yanhao, Mutual Fund Flows and Performance in (Imperfectly) Rational Markets? (May 5, 2020). Jacobs Levy Equity Management Center for Quantitative Financial Research Paper , Available at SSRN: https://ssrn.com/abstract=3744290 or http://dx.doi.org/10.2139/ssrn.3744290

Nikolai L. Roussanov (Contact Author)

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Hongxun Ruan

Guanghua School of Management, Peking University ( email )

Peking University
Beijing, Beijing 100871
China

Yanhao Wei

University of Southern California - Marshall School of Business ( email )

701 Exposition Blvd
Los Angeles, CA California 90089
United States

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