Discontinued Positive Feedback Trading and the Decline of Return Predictability

Itzhak Ben-David, Jiacui Li, Andrea Rossi and Yang Song

No 28624, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: We show that demand effects generated by institutional frictions can influence systematic return predictability patterns in stocks and mutual funds. Identification relies on a reform to the Morningstar rating system, which we show caused a structural break in style-level positive feedback trading by mutual funds. As a result, momentum-related factors in stocks, as well as performance persistence and the “dumb money effect” in mutual funds, experienced sharp decline. Consistent with the proposed channel, return predictability declined right after the reform, was limited to the U.S. market, and was concentrated in factors and mutual funds most exposed to the mechanism.

JEL-codes: G11 G24 G41 (search for similar items in EconPapers)
Date: 2021-03
Note: AP CF
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Journal Article: Discontinued Positive Feedback Trading and the Decline of Return Predictability (2024)
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