Time-Varying Risk Aversion in the Cross-Section of Mutual Fund Flows

Abstract

Analyzing cross sectional determinants of fund flows, this study finds evidence that investors’ risk aversion is time-varying. In particular, the periods over which the increases in risk aversion are observed are associated with contemporaneously low market returns, suggesting that increases in aggregate risk aversion increases the discount rate thereby lowering market prices. While the relation is more pronounced across equity funds, a marginally significant increase in risk-aversion during periods of low bond returns was also observed. Furthermore, the study finds that bond investors are generally more risk averse than equity investors, and that equity and bond investors engage in comparatively less performance chasing during periods with low market returns. This study adds to the growing body of research, which suggests that risk-aversion and consequently risk premia are time-varying, providing a risk-based explanation for phenomena such as long-run stock return predictability.