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Models or Stars: The Role of Asset Pricing Models and Heuristics in Investor Risk Adjustment
[Which factors matter to investors? evidence from mutual fund flows]

Author

Listed:
  • Richard B Evans
  • Yang Sun

Abstract

We examine the role of factor models and simple performance heuristics in investor decision-making using Morningstar’s 2002 rating methodology change. Before the change, flows strongly correlated with CAPM alphas. After, when funds are ranked by size and book-to-market groups, flows become more sensitive to 3-factor alphas (FF3). Flows to a matched institutional sample (same managers/strategies) follow FF3 before and after the change but are unrelated to the CAPM. Placebo tests with sector funds and other factor loadings show no effects. Our results imply that improvements in simple performance heuristics can result in more sophisticated risk adjustment by retail investors.

Suggested Citation

  • Richard B Evans & Yang Sun, 2021. "Models or Stars: The Role of Asset Pricing Models and Heuristics in Investor Risk Adjustment [Which factors matter to investors? evidence from mutual fund flows]," The Review of Financial Studies, Society for Financial Studies, vol. 34(1), pages 67-107.
    • Handle: RePEc:oup:rfinst:v:34:y:2021:i:1:p:67-107.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhaa043
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    More about this item

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets
    • G53 - Financial Economics - - Household Finance - - - Financial Literacy

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