Prospect theory preferences and global mutual fund flows

• Published in: Journal of international money and finance 2022-07, Vol.125, p.102640, Article 102640
• Main Authors: Gupta, Nilesh, Mishra, Anil V, Jacob, Joshy
• Format: Article
• Language: English
• Subjects: biases; Cumulative Prospect Theory; Fund flows; mutual funds
• ISSN: 0261-5606; 1873-0639
• DOI: 10.1016/j.jimonfin.2022.102640

•Prospect theory preferences influence mutual fund flows.•Speculative investments by fund managers are inversely related to fund performance.•Fund flow of retail-oriented funds more susceptible to Prospect theory preferences.•Greater fund flow sensitivity to speculative characteristics in countries with higher individualism and short-term orientation. We examine the influence of Cumulative Prospect Theory (CPT) characteristics of fund returns on investment flows with a cross-country data of equity mutual funds. We find that a larger CPT value of the style-adjusted past returns is associated with higher fund flows in the subsequent quarter. The impact is greater for retail-oriented funds, relatively younger funds, and those with higher active share. While funds that score high on the CPT value attract incremental fund flows, they earn a lower alpha than their peers in the following year. The sensitivity of fund flows to the CPT characteristics is higher in countries with greater individualism and short-term orientation. The results are robust to several additional tests and hold across various subsamples of our data. The findings imply that investors have misplaced expectations about the future performance of funds that show higher CPT values and the fund managers cater to these investor preferences.