Working Paper: NBER ID: w28103
Authors: Itzhak Bendavid; Jiacui Li; Andrea Rossi; Yang Song
Abstract: We show that mutual fund ratings generate correlated demand that creates systematic price fluctuations. Mutual fund investors chase fund performance via Morningstar ratings. Until June 2002, funds pursuing the same investment style had highly correlated ratings. Therefore, rating-chasing investors directed capital into winning styles, generating style-level price pressures, which reverted over time. In June 2002, Morningstar reformed its methodology of equalizing ratings across styles. Style-level correlated demand via mutual funds immediately became muted, significantly altering the time-series and cross-sectional variation in style returns.
Keywords: No keywords provided
JEL Codes: G11; G24; G41
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| mutual fund ratings (G23) | correlated demand (R22) |
| correlated demand (R22) | systematic price fluctuations (E30) |
| increase in ratings (G24) | surge in mutual fund flows (G23) |
| surge in mutual fund flows (G23) | contemporaneous stock price appreciation (G19) |
| contemporaneous stock price appreciation (G19) | subsequent reversals (Y50) |
| methodological reform by Morningstar (C51) | collapse in dispersion of ratings and flows (D79) |
| collapse in dispersion of ratings and flows (D79) | significant causal impact on stock market dynamics (G41) |
| prior to the reform (N93) | larger inflows into upgraded styles (F12) |
| larger inflows into upgraded styles (F12) | momentum and subsequent reversals in returns (G41) |
| post-reform (P21) | more evenly distributed inflows and returns (D39) |
| 2002 reform (E69) | long-lasting impact on capital allocation across styles (G11) |