Saliency Bias in Mutual Fund Portfolios: Evidence from a Natural Experiment

Abstract

We examine whether professional money managers overreact to the salient events using hurricane strikes as a natural experiment. Following the hurricane strike, managers close to the disaster (hurricane strike) zone underweight disaster zone firms more than the distant managers. The underweighting of disaster zone firms is not driven by information asymmetry between the close and distant managers, rather it is driven by saliency bias. This saliency bias decreases with both time and distance. Finally, the managerial overreaction is costly to the fund investors. A long-short strategy exploiting the extent of overreaction by close fund managers generates economically and statistically significant risk-adjusted returns.