Discontinued Positive Feedback Trading and the Decline in Asset Pricing Factor Profitability

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

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

56 Pages Posted: 22 Mar 2021 Last revised: 23 Mar 2021

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: March 20, 2021

Abstract

We show that a June 2002 reform in Morningstar’s mutual fund rating methodology led to substantial drop in the profitability of momentum-related asset pricing factors. Before the reform, funds pursuing the same investment style had correlated ratings heavily influenced by recent style performance. Therefore, ratings-chasing flows generated large style-level positive feedback trading. The reform decoupled ratings from style-level performance; consequently, factors that benefited from positive feedback trading experienced a precipitous return decline. The performance decline was limited to the U.S. market where the reform happened. We estimate that the reform explains 25%–50% of the long-term profitability drop in momentum-related factors.

Keywords: positive feedback trading, mutual funds, anomalies, 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 in Asset Pricing Factor Profitability (March 20, 2021). 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
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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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