On absolute and relative performance and the demand for mutual funds - experimental evidence

Empirically, mutual fund flows depend on past performance. It is unclear, however, whether this is rational. Using experiments, we overcome measurement problems of real data. We detect two anomalies: (1) "absolute performance effect"-investors' tendency to delegate money to a fund increases with performance, even when performance is uninformative; (2) "relative performance effect"-investors' tendency to delegate money decreases with other funds' performance, even when their performance is attributed to luck per se. We suggest two descriptive alternatives to expected utility: (1) "subjective conditional probability"-subjective probabilities deviate from Bayesian posteriors; (2) "subjective risk aversion"-a history-dependent utility function. (C) 2003 Elsevier B.V. All rights reserved.