Participation costs and the sensitivity of fund flows to past performance

Participation costs and the sensitivity of fund flows to past performance

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Article ID: iaor2009770
Country: United Kingdom
Volume: 62
Issue: 3
Start Page Number: 1273
End Page Number: 1311
Publication Date: Jun 2007
Journal: Journal of Finance
Authors: , ,
Keywords: investment
Abstract:

We present a simple rational model to highlight the effect of investors' participation costs on the response of mutual fund flows to past fund performance. By incorporating participation costs into a model in which investors learn about managers' ability from past returns, we show that mutual funds with lower participation costs have a higher flow sensitivity to medium performance and a lower flow sensitivity to high performance than their higher-cost peers. Using various fund characteristics as proxies for the reduction in participation costs, we provide empirical evidence supporting the model's implications for the asymmetric flow–performance relationship.

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