Economic Policy Uncertainty, Learning and Incentives: Theory and Evidence on Mutual Funds

Abstract

Using the mutual fund industry as a laboratory, we demonstrate theoretically and empirically that economic policy uncertainty affects investment decisions through an information rather than real options channel. Specifically, we find that fund flow-performance sensitivity decreases in uncertainty and does so more strongly for funds with shorter track records. The evidence supports the implication of our model that investor learning about manager ability weakens when uncertainty increases. Further, the effect of uncertainty on learning impacts managerial incentives. Consequently, managers are less likely to engage in active management during periods of greater uncertainty, an effect increasing in career concerns.