Prospect Theory and Mutual Fund Flows
49 Pages Posted: 28 Jun 2021
Date Written: April 2021
Abstract
Using mutual fund flow, we empirically test whether choices made by investors are consistent with preferences implied by prospect theory. Our findings support this hypothesis. When allocating capital to mutual funds, investors evaluate funds based on the past performance distribution and choose the ones that deliver the highest utility according to prospect theory. This predictive relation is robust when we control for a large set of known drivers of fund flows, notably alphas. The pattern is more salient among retail and less sophisticated investors. Moreover, all the features of prospect theory contribute to the predictive power.
Keywords: Prospect Theory, Mutual Funds, Asset Pricing, Behavioral Finance
JEL Classification: G11, G40
Suggested Citation: Suggested Citation