Mutual Fund Flows and Performance in Rational Markets
Mutual Fund Flows and Performance in Rational
Markets
Jonathan B. Berk
University of California, Berkeley and National Bureau of Economic Research
Richard C. Green
Carnegie Mellon University
We derive a parsimonious rational model of active portfolio management that reproduces many regularities widely regarded as anomalous.
Fund flows rationally respond to past performance in the model even though performance is not persistent and investments with active managers do not outperform passive benchmarks on average. The lack of persistence in returns does not imply that differential ability across managers is nonexistent or unrewarded or that gathering information about performance is socially wasteful. The model can quantitatively reproduce many salient features in the data. The flow-performance relationship is consistent with high average levels of skills and considerable heterogeneity across managers.
One of the central mysteries facing financial economics is why financial intermediaries appear to be so highly rewarded, despite the apparent fierce competition between them and the uncertainty about whether
We would like to thank Avi Bick, Jennifer Carpenter, Hsiu-lang Chen, Gian Luca Clementi, John Cochrane (the editor), Jeff Coles, Josh Coval, Ravi Jagannathan, Burton
Hollifield, Dwight Jaffee, Finn Kydland, Mike Lemmon, David Musto, Walter Novaes,
George Pennacchi, Raj Singh, Peter Tufano, Uzi Yoeli, Lu Zheng, and two anonymous referees for their helpful comments and suggestions. Seminar participants at several conferences and universities also provided useful feedback and suggestions. We also gratefully acknowledge financial support from the Q Group, the National Science Foundation
(Berk), and the International Center for Financial Asset Management and Engineering through the 2003 FAME Research Prize.
[Journal of Political Economy, 2004, vol. 112, no. 6]
᭧ 2004 by The University of Chicago. All rights reserved.
Markets
Jonathan B. Berk
University of California, Berkeley and National Bureau of Economic Research
Richard C. Green
Carnegie Mellon University
We derive a parsimonious rational model of active portfolio management that reproduces many regularities widely regarded as anomalous.
Fund flows rationally respond to past performance in the model even though performance is not persistent and investments with active managers do not outperform passive benchmarks on average. The lack of persistence in returns does not imply that differential ability across managers is nonexistent or unrewarded or that gathering information about performance is socially wasteful. The model can quantitatively reproduce many salient features in the data. The flow-performance relationship is consistent with high average levels of skills and considerable heterogeneity across managers.
One of the central mysteries facing financial economics is why financial intermediaries appear to be so highly rewarded, despite the apparent fierce competition between them and the uncertainty about whether
We would like to thank Avi Bick, Jennifer Carpenter, Hsiu-lang Chen, Gian Luca Clementi, John Cochrane (the editor), Jeff Coles, Josh Coval, Ravi Jagannathan, Burton
Hollifield, Dwight Jaffee, Finn Kydland, Mike Lemmon, David Musto, Walter Novaes,
George Pennacchi, Raj Singh, Peter Tufano, Uzi Yoeli, Lu Zheng, and two anonymous referees for their helpful comments and suggestions. Seminar participants at several conferences and universities also provided useful feedback and suggestions. We also gratefully acknowledge financial support from the Q Group, the National Science Foundation
(Berk), and the International Center for Financial Asset Management and Engineering through the 2003 FAME Research Prize.
[Journal of Political Economy, 2004, vol. 112, no. 6]
᭧ 2004 by The University of Chicago. All rights reserved.
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