Working Paper: NBER ID: w20435
Authors: Jonathan B. Berk; Jules H. Van Binsbergen
Abstract: We propose a new method of testing asset pricing models that relies on using quantities rather than prices or returns. We use the capital flows into and out of mutual funds to infer which risk model investors use. We derive a simple test statistic that allows us to infer, from a set of candidate models, the model that is closest to the model that investors use in making their capital allocation decisions. Using this methodology, we find that of the models most commonly used in the literature, the Capital Asset Pricing Model is the closest. The finding that investors’ revealed preferences are most aligned with the Capital Asset Pricing Model despite the fact that the model has been shown to perform poorly relative to other models in explaining cross sectional variation in expected returns, is an important puzzle for future research. We also document that a large fraction of mutual fund flows remain unexplained.
Keywords: Asset Pricing; Mutual Funds; Investor Behavior; Revealed Preference
JEL Codes: D14; D24; E2; E22; E44; G0; G1; G10; G11; G12; G2; G20; G23
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Investors' capital allocation decisions (G11) | Capital Asset Pricing Model (CAPM) (G12) |
| Positive abnormal returns in mutual funds (G11) | Capital inflows (F21) |
| Capital Asset Pricing Model (CAPM) (G12) | Investor behavior (G41) |
| CAPM better explains mutual fund flows (G11) | No model at all (C59) |
| Investors' reliance on non-risk-based criteria (G11) | Investment decisions (G11) |