Prospect Theory and Mutual Fund Flows

Gu, Ariel; Yoo, Hong Il

Abstract

We evaluate the hypothesis that investors seek portfolios that display attractive return distributions in terms of Prospect Theory (PT). We consider the mutual fund market in the U.S. as an interesting testbed because fund investors are known to be return-chasing and about a half of U.S. households own mutual funds. Using monthly flow data from 1999-2019, we find that mutual funds attract higher net flows when they have better PT values. We obtain similar results when PT is replaced with Rank-Dependent Utility, a closely related theory that does not require a particular choice of reference points. Our results are consistent with recent evidence that fund flows exhibit heightened sensitivity to extreme performance measures.

Citation

Gu, A., & Yoo, H. I. (2021). Prospect Theory and Mutual Fund Flows. Economics Letters, 201, Article 109776. https://doi.org/10.1016/j.econlet.2021.109776

• Journal Article Type: Article
• Acceptance Date: Feb 7, 2021
• Online Publication Date: Feb 11, 2021
• Publication Date: 2021-04
• Deposit Date: Feb 15, 2021
• Publicly Available Date: Aug 11, 2022
• Journal: Economics Letters
• Print ISSN: 0165-1765
• Electronic ISSN: 1873-7374
• Publisher: Elsevier
• Peer Reviewed: Peer Reviewed
• Volume: 201
• Article Number: 109776
• DOI: https://doi.org/10.1016/j.econlet.2021.109776
• Public URL: https://durham-repository.worktribe.com/output/1280355