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Prospect Theory and Mutual Fund Flows

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  • 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.

Suggested Citation

  • Gu, Ariel & Yoo, Hong Il, 2021. "Prospect Theory and Mutual Fund Flows," Economics Letters, Elsevier, vol. 201(C).
    • Handle: RePEc:eee:ecolet:v:201:y:2021:i:c:s0165176521000537
    DOI: 10.1016/j.econlet.2021.109776
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    References listed on IDEAS

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    Cited by:

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    3. Giannikos, Christos I. & Kakolyris, Andreas & Suen, Tin Shan, 2023. "Prospect theory and a manager's decision to trade a blind principal bid basket," Global Finance Journal, Elsevier, vol. 55(C).

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    More about this item

    Keywords

    Prospect theory; Mutual fund; Portfolio choice; Behavioral finance; Non-expected utility;
    All these keywords.

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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