Review of Financial Studies Vol. 25 No. 12 2012
A Flow-Based Explanation for Return Predictability
Abstract
[I propose and test a capital-flow-based explanation for some well-known empirical regularities concerning return predictability—the persistence of mutual fund performance, the "smart money" effect, and stock price momentum. First, I construct a measure of demand shocks to individual stocks by aggregating flow-induced trading across all mutual funds, and document a significant, temporary price impact of such uninformed trading. Next, given that mutual fund flows are highly predictable, I show that the expected part of flow-induced trading positively forecasts stock and mutual fund returns in the following year, which are then reversed in subsequent years. The main findings of the paper are that the flow-driven return effect can fully account for mutual fund performance persistence and the smart money effect, and can partially explain stock price momentum.]
- Volume
- 25
- Issue
- 12
- Pages
- 3457-3489
- Sources
- bibtex:phds-export.bib