Flight-to-safety and retail investor behavior

Thorsten Lehnert

International Review of Financial Analysis, 2022, vol. 81, issue C

Abstract: Flight-to-safety (FTS) episodes are associated with substantial yet short-lived changes in expected returns on equities and bonds. These price changes are typically surrounded by active trading and/or risk transfer between different investors. Using aggregate net exchanges, flows from bond to equity mutual funds, in the US for a period 1984 until 2015, I empirically investigate retail investor behavior around FTS episodes. Overall, I find a reversal statistical relation between net exchanges and market excess returns. A one-standard-deviation shock to net exchanges leads to an increase of market excess return of 1.75%, of which 72% is reversed within 5 months. In particular, FTS episodes are preceded by periods where more risk averse investors, e.g. retail investors, rebalance their portfolios towards risky assets. A trading strategy that is based on signals from past net exchanges outperforms the market portfolio, significantly during FTS periods by 1.4% monthly. However, I find that the observed reversal relationship is not necessarily due to price ‘noise’ induced by uninformed trading. It is more reasonable that the sudden increase in market stress and selling of risky assets is caused by other demand/supply shocks driven by increased economic uncertainty.

Keywords: Flight-to-safety; Mutual funds; Fund flows; Net exchanges; Economic uncertainty; Risk aversion; Price noise (search for similar items in EconPapers)
JEL-codes: G11 G12 G14 (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finana:v:81:y:2022:i:c:s1057521922001090

DOI: 10.1016/j.irfa.2022.102142

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