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Participation Costs and the Sensitivity of Fund Flows to Past Performance

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  • JENNIFER HUANG
  • KELSEY D. WEI
  • HONG YAN

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. Copyright 2007 by The American Finance Association.

Suggested Citation

  • Jennifer Huang & Kelsey D. Wei & Hong Yan, 2007. "Participation Costs and the Sensitivity of Fund Flows to Past Performance," Journal of Finance, American Finance Association, vol. 62(3), pages 1273-1311, June.
  • Handle: RePEc:bla:jfinan:v:62:y:2007:i:3:p:1273-1311
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