Discontinued Positive Feedback Trading and the Decline of Return Predictability

Fisher College of Business Working Paper No. 2021-03-03

Charles A. Dice Center Working Paper No. 2021-03

50 Pages Posted: 22 Mar 2021 Last revised: 16 May 2022

See all articles by Itzhak Ben-David

Itzhak Ben-David

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)

Jiacui Li

David Eccles School of Business, University of Utah

Andrea Rossi

University of Arizona - Department of Finance

Yang Song

University of Washington - Michael G. Foster School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: May 15, 2022

Abstract

We show that demand effects generated by institutional frictions can influence systematic return predictability patterns in stocks and mutual funds. Identification relies on a reform to the Morningstar rating system, which we show caused a structural break in style-level positive feedback trading by mutual funds. As a result, momentum-related factors in stocks, as well as performance persistence and the "dumb money effect" in mutual funds, experienced sharp decline. Consistent with the proposed channel, return predictability declined right after the reform, was limited to the U.S. market, and was concentrated in factors and mutual funds most exposed to the mechanism.

Keywords: positive feedback trading, mutual funds, anomalies, momentum, factor momentum

JEL Classification: G11, G24, G41

Suggested Citation

Ben-David, Itzhak and Li, Jiacui and Rossi, Andrea and Song, Yang, Discontinued Positive Feedback Trading and the Decline of Return Predictability (May 15, 2022). Fisher College of Business Working Paper No. 2021-03-03, Charles A. Dice Center Working Paper No. 2021-03, Available at SSRN: https://ssrn.com/abstract=3808853 or http://dx.doi.org/10.2139/ssrn.3808853

Itzhak Ben-David

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Fisher 700D
Columbus, OH 43210-1144
United States
773 988 1353 (Phone)

HOME PAGE: http://https://u.osu.edu/ben-david.1/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://fisher.osu.edu/fin/faculty/Ben-David/

Jiacui Li

David Eccles School of Business, University of Utah ( email )

8123 SFEBB, 1655 Campus Center Dr
Salt Lake City, UT 84112
United States

HOME PAGE: http://https://www.jiacui-li.com/

Andrea Rossi

University of Arizona - Department of Finance ( email )

McClelland Hall
P.O. Box 210108
Tucson, AZ 85721-0108
United States

Yang Song (Contact Author)

University of Washington - Michael G. Foster School of Business ( email )

Box 353200
Seattle, WA 98195-3200
United States

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