Mutual Fund Risk Shifting and Risk Anomalies

Brown Bag Seminar（2021-02)

Finance Webinar（2021-14)

Topic: Mutual Fund Risk Shifting and Risk Anomalies

Speaker: Hongxun Ruan, Peking University

Time: Friday, April 16, 12:00–1:00 PM Beijing Time

Location: Room 213, Guanghua Building 2; You are also welcome to join online via Microsoft Teams conference room

Abstract:

Risk-shifting by under-performing mutual funds leads them to increase portfolio allocations to riskier stocks, in particular, increasing their beta with respect to the relevant benchmark index towards year-end. We show that this demand for high-risk stocks goes a long way towards explaining the well-known risk anomalies (e.g., ``betting against beta''). We exploit the fact that Morningstar ratings are a powerful driver of fund flows, which, in turn, create incentives for the risk-shifting behavior. We use an exogenous change in the rating methodology adopted by Morningstar in 2002, whereby it began assigning ``star'' ratings based on relative performance within a style category rather than across the entire fund universe, to show that funds that under-perform their category peers invest more in stocks with higher exposures to the (relevant) common benchmark. We discover a significant beta anomaly concentrated among stocks held by under-performing funds, but only for beta with the S&P 500 index for the pre-2002 period and only for beta with respect to the relevant category index for the post-2002 period. Further, we find evidence that other risk anomalies, such as those associated with idiosyncratic-volatility and skewness/lottery-like payoff are also more significant among stocks held by under-performing funds.

Your participation is warmly welcomed!