Do Investors Care about Tail Risk? Evidence from Mutual Fund Flows

Abstract

This paper examines investor attitude toward tail risk in investment decision-making. Based on a large sample of mutual funds, we show that investor flows are significantly sensitive to tail risk in the cross-section, even after controlling for fund performance and characteristics. Using terrorist attacks and COVID-19 as exogenous shocks to the investor fear level, we find that fund flows become increasingly sensitive to tail risk following the shocks, suggesting that fear is a driving force of the tail risk aversion. In particular, the flow-tail risk sensitivity during the onset of COVID-19 is about 4.5-10 times as large as that in other periods. In addition, tail risk is associated with the activeness of mutual fund investment strategies. The results are robust to alternative measures of tail risk. Overall, our findings suggest that investors care about tail risk beyond traditional risks.