Discontinued Positive Feedback Trading and the Decline of Return Predictability

50 Pages Posted: 29 Mar 2021 Last revised: 23 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: March 2021

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.

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Suggested Citation

Ben-David, Itzhak and Li, Jiacui and Rossi, Andrea and Song, Yang, Discontinued Positive Feedback Trading and the Decline of Return Predictability (March 2021). NBER Working Paper No. w28624, Available at SSRN: https://ssrn.com/abstract=3814613

Itzhak Ben-David (Contact Author)

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

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Jiacui Li

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

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

Andrea Rossi

University of Arizona - Department of Finance ( email )

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Tucson, AZ 85721-0108
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Yang Song

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

Box 353200
Seattle, WA 98195-3200
United States

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