Fund Flows in Rational Markets

by Sabrina I. Pacifici on May 14, 2013

Franzoni, Francesco A. and Schmalz, Martin C., Fund Flows in Rational Markets (May 12, 2013). Available at SSRN

  • “When investors are risk-averse, relative performance in downturns is more informative about managers’ ability to generate utility for investors than relative performance in upturns. Rational investors thus reallocate more wealth between funds in response to downturn-performance than in response to upturn-performance, resulting in higher flow-performance sensitivities in downturns than in upturns. Combined with decreasing returns to scale, our model also explains why mutual fund returns are more persistent following market upturns than following market downturns. We identify the model by empirically testing its cross-sectional, difference-in-differences, and auxiliary predictions for the flow-performance sensitivity.”
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