Flow-Based Asset Pricing: A Factor Framework of Cross-Sectional Price Impacts

Abstract

We study how noisy flows impact the cross-section of asset prices. Our framework emphasizes the interaction between the factor structure of flows and the risk structure of assets. Specifically, systematic flows into systematic risk factors imply a factor model of price impacts. We develop empirical methods for the model by introducing flows into classical portfolio tools, including the Sharpe ratio, the Fama-MacBeth regression, the Fama-French portfolios, and the Gibbons-Ross-Shanken test. We estimate the model using U.S. equity mutual fund flows data. The model-implied strategy that optimally profits from flows improves the investment performance of most existing characteristics-based anomaly portfolios.

Keywords: cross-section, factor, flow, price impact, risk

JEL Classification: G12