Prospect Theory in the Field: Revealed Preferences from Mutual Fund Flows

Abstract

Using mutual fund flows, we evaluate prospect theory with choice outcomes in the market. We provide strong support for prospect theory: under a standard set of parameters, funds whose past returns generate higher prospect theory value attract significantly larger future flows; we also find corroborative evidence using account-level data. Taking a revealed preference approach, we estimate the prospect theory parameters through a discrete choice model and find that our field-based estimates align well with previous experiment-based estimates. Moreover, we show that prospect theory offers a new framework for understanding flows, as it has explanatory power over and above existing drivers.

Keywords: Prospect Theory, Revealed Preference, Investor Demand, Mutual Funds

JEL Classification: G11, G40