Prior beliefs in market efficiency and fund cash flows

Abstract

This study investigates the effect of fund investors' prior beliefs on flow-performance relationships. Nonmonotonic inflow- and outflow-performance relationships, with a monotonic relationship in net flows, suggest that more investors exhibit return-chasing behaviour but that some investors behave in a strongly biased manner; these phenomena exist in high-risk funds with extreme performance. With regard to investors' prior beliefs in market efficiency to the fund performance, inflows and outflows have a monotonic relationship with performance. From these findings, the nonmonotonic relationship can be explained by the biased behaviour resulting from the lack of beliefs in market efficiency.