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Mutual funds, part II: fund flows and security returns

  • Peter Fortune
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    Mutual funds played a very small role in the financial system until the 1970s, before which ownership of financial instruments was dominated by commercial banks, thrift institutions, insurance companies, and pension funds. The financial system of the 1990s is not simply the system of the 1970s with more mutual funds, however. Evolution in financial laws and regulations, increasing global interactions, the rise of new financial instruments, major shifts in the structure and nature of financial institutions, and a change in the locus of risk-bearing from institutions to individuals have also shaped investors' decisions.> The goal of this study is to assess the historical evidence to see whether the interactions between mutual fund inflows and outflows and asset prices are potentially destabilizing to security markets. The author addresses some issues of shareholder behavior and the differences between direct ownership and pooled ownership of securities. He presents an econometric analysis of the interactions between security returns and mutual fund flows, and he uses his model to trace out the effect of shocks to security returns and fund flows. In contrast to previous studies, he finds that security returns do affect future fund flows, and that some fund flows do affect future security returns. But he finds no persistence in security returns—shocks to, say, stock returns do not imply further changes in stock returns, so the rationale for momentum trading over a longer period finds no support.

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    Article provided by Federal Reserve Bank of Boston in its journal New England Economic Review.

    Volume (Year): (1998)
    Issue (Month): Jan ()
    Pages: 3-22

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    Handle: RePEc:fip:fedbne:y:1998:i:jan:p:3-22
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    1. Wallace N. Davidson III & Dipa Dutia, 1989. "A Note On The Behavior Of Security Returns: A Test Of Stock Market Overreaction And Efficiency," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 12(3), pages 245-252, 09.
    2. Warther, Vincent A., 1995. "Aggregate mutual fund flows and security returns," Journal of Financial Economics, Elsevier, vol. 39(2-3), pages 209-235.
    3. Eli M. Remolona & Paul Kleiman & Debbie Gruenstein, 1997. "Market returns and mutual fund flows," Economic Policy Review, Federal Reserve Bank of New York, issue Jul, pages 33-52.
    4. Davidson, Wallace N, III & Dutia, Dipa, 1989. "A Note on the Behavior of Security Returns: A Test of Stock Market Overreaction and Efficiency," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 12(3), pages 245-52, Fall.
    5. Peter Fortune, 1997. "Mutual funds, part I: reshaping the American financial system," New England Economic Review, Federal Reserve Bank of Boston, issue Jul, pages 45-72.
    6. Granger, C W J, 1969. "Investigating Causal Relations by Econometric Models and Cross-Spectral Methods," Econometrica, Econometric Society, vol. 37(3), pages 424-38, July.
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