When assessing a fund manager's skill, sophisticated investors will consider all factors (priced and unpriced) that explain cross-sectional variation in fund performance. We investigate which factors investors attend to by analyzing mutual fund flows as a function of recent returns decomposed into alpha and factor-related returns. Surprisingly, investors attend most to market risk (beta) when evaluating funds and treat returns attributable to size, value, momentum, and industry factors as alpha. Using proxies for investor sophistication (wealth, distribution channels, and periods of high investor sentiment), we find that more sophisticated investors use more sophisticated benchmarks when evaluating fund performance.

Anecdotal and indirect empirical evidence suggest that excitement and market bubbles are intertwined, such that excitement not only arises during bubbles but may also help fuel them. We directly test the impact of excitement on bubbles in a bubble-prone experimental asset-pricing market ( Capinalp, Porter, and Smith, 2001 ). Prior to trading, participants are assigned to emotion inductions through video clips The results of fifty-five markets show larger asset pricing bubbles in magnitude and amplitude in the excitement treatment relative to a treatment of same valence and lower intensity ( calm ) and a treatment of similar intensity and opposite valence ( fear ).

When assessing a fund manager's skill, sophisticated investors will consider all factors (priced and unpriced) that explain cross-sectional variation in fund performance. We investigate which factors investors attend to by analyzing mutual fund flows as a function of recent returns decomposed into alpha and factor-related returns. Surprisingly, investors attend most to market risk (beta) when evaluating funds and treat returns attributable to size, value, momentum, and industry factors as alpha. Using proxies for investor sophistication (wealth, distribution channels, and periods of high investor sentiment), we find that more sophisticated investors use more sophisticated benchmarks when evaluating fund performance.