Participation Costs and the Sensitivity of Fund Flows to Past Performance





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    • Huang is at the McCombs School of Business, University of Texas at Austin. Wei is at the School of Management, University of Texas at Dallas. Yan is at the Moore School of Business, University of South Carolina. We thank Jonathan Berk, Keith Brown, Wayne Ferson, Alexei Goriaev, Anthony Lynch, David Musto, Lubos Pastor, Lukasz Pomorski, Brian Reid, Mark Seasholes, Clemens Sialm, Erik Sirri, Laura Starks, Sheridan Titman, Jay Wellman, Tong Yao, Lu Zheng, and an anonymous referee for insightful suggestions, and presentation participants at Australian Graduate School of Management, Boston University, Cheung Kong Graduate School of Business, the U.S. Securities & Exchange Commission, the University of Texas at Austin, the 2004 European Finance Association meeting, the 2005 China International Conference in Finance, the 2005 Michigan Mitsui Life Symposium, the 2005 Texas Finance Festival, and the 2005 Western Finance Association meeting for useful comments. All remaining errors are our own.


We present a simple rational model to highlight the effect of investors' participation costs on the response of mutual fund flows to past fund performance. By incorporating participation costs into a model in which investors learn about managers' ability from past returns, we show that mutual funds with lower participation costs have a higher flow sensitivity to medium performance and a lower flow sensitivity to high performance than their higher-cost peers. Using various fund characteristics as proxies for the reduction in participation costs, we provide empirical evidence supporting the model's implications for the asymmetric flow-performance relationship.