Do Investment Flows Drive the Disposition Effect on Fund Managers?

Abstract

This paper analyzes the relationship between fund flow and fund managers' trading behavior with regard to the disposition effect, which is as the tendency of fund managers cash more winner stocks of portfolio holdings rather than losers. The evidence shows that the disposition effect (DE) exists among professional fund managers and the effect is linearly and negatively correlated with the magnitude of fund flow. We find that the trading behavior is sensitive to unexpected outflow, which leads to a higher DE for fund managers. Moreover, we find fund managers with a DE trading bias would incur greater losses when there is fund inflow. Which suggests that higher exit cost of fund redemption fees could efficiently reduces flow uncertainty and trading bias possibility. On the contrary, selling winners is more prevalent among worse performing funds, while the tendency of selling winners seems brings short-term benefit for those outflow funds. We contribute to the literature by further examine how fund managers deal with winning or losing holdings under conditions of flow pressure and evaluate how flow-motivated trade of institutional investors influence on fund performance.