Academic journal article The International Journal of Business and Finance Research

The Influences of Greed and Fear on Fund Performance

Academic journal article The International Journal of Business and Finance Research

The Influences of Greed and Fear on Fund Performance

Article excerpt

ABSTRACT

This paper discusses if the psychological changes of investors would influence mutual funds from the perspective of behavioral finance. In other words, we assess the psychological state of investors from the deepest psychological factors of greed and fear, and discuss whether the psychological changes in these investors would influence a mutual fund. This study presented evidence that the psychological changes of investors were related to fund performance. It better illustrated how fund performance was affected by the psychology of investors, especially from irrational behavior driven by fear and greed.

JEL: C33, C58, G02

KEYWORDS: Volatility Index (VIX), Greed, Fear, Mutual Fund Performance

(ProQuest: ... denotes formulae omitted.)

INTRODUCTION

Ever since the efficient market hypothesis (EMH) was proposed by Fama (1970), the field of finance has seen a continuous wave of research on mutual funds. It is popular in academic studies to discuss whether the performance of a mutual fund can beat the market and maintain a positive anomalous performance. Overall fund performance was earlier assessed by the return rate and overlooked the underlying risks that funds should undertake. In recent years, however, the underlying risks of a fund have been considered for an overall performance assessment. Assessed indices include the Treynor Index (1965), the Sharpe Index (1966), and the Jensen Index (1968), among others. Fund performance is influenced by many factors. Study results have indicated that fund performance may be related to its size, flow, turnover period, the management fee rates, and the ratio of expenses to sales. Recently, researchers have begun to discuss the relationship between fund performance, emotion, and herding behavior. Related study results have shown that investors purchase funds with a better performance history and redeem those with a worse performance history (Elton, Gruber and Busse, 2004; Barber, Odean, and Zheng, 2005). Additionally, funds with a worse performance had a higher price (GilBazo and Ruiz-Verdu, 2009). These factors are considered the main two conundrums of mutual funds.

When a mutual fund is able to maintain a positive anomaly, it means that the market is inefficient and may not be rational. When fund investors purchase a fund based on its performance history or purchase a fund with a higher price but a worse performance, it means that the investors are acting irrationally. In recent years, behavior finance has drawn greater attention. Related literature has agreed that investors show many types of behavioral biases and not all are rational. For example, Odean (1998, 1999) and Barber and Odean (2001) discovered that some investors exhibited all kinds of behavioral biases when making stock investment decisions. In a recent study, Bailey, Kumar, and Ng (2011) analyzed the data of several mutual fund investors and discovered that they had behavioral biases, such as disposition effect, narrow framing, overconfidence, and speculation preference as well as local bias. The irrational behavior of investors may influence market returns and cause fluctuations that further influence the operation and performance of a mutual fund. In another sense, the emotional fluctuations of investors, especially changes between greed and fear, may lead to price variations. Fund managers may try to cater to or take advantage of such market opportunities caused by the emotional changes between greed and fear to gain abnormal returns. In this circumstance, fund performance will be related to the greed and fear of investors. Related literature has discussed the influence of investor irrational psychology on fund performance but has not drawn clear conclusions. In addition, the existing literature has not presented evidence to explain how the psychology of investors influences portfolio performance. Therefore, the ways that greed and fear influence fund performance have academic implications and are worthy of discussion. …

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