A flow-based explanation for return predictability

Dong Lou

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: This paper proposes and tests an investment-flow based explanation for three empirical findings on return predictability - the persistence of mutual fund performance, the 'smart money' effect, and stock price momentum. Since mutual fund managers generally scale up or down their existing positions in response to investment flows, and the portfolios of funds receiving capital generally differ from those that lose capital, investment flows to mutual funds can cause signicant demand shocks in individual stocks. Moreover, given that mutual fund flows are largely predictable from past fund performance and past flows, this paper further establishes that flow-induced price pressure is predictable. Finally, this paper shows that such flow-based return predictability can fully account for mutual fund performance persistence and the 'smart money' effect, and can partially explain stock price momentum.

JEL-codes: G10 (search for similar items in EconPapers)
Pages: 56 pages
Date: 2009-11-03
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (8)

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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:29310

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