Winston Wei Dou

Common Fund Flows: Flow Hedging and Factor Pricing

Joint with Leonid Kogan, Wei Wu

Journal of Finance Revise and Resubmit, October 2020


Active mutual fund managers care about fund size, which is affected by common fund flows driven by macroeconomic shocks. Fund managers hedge against common flow shocks by tilting their portfolios toward low-flow-beta stocks. In equilibrium, common flow shocks earn a risk premium. A multi-factor asset pricing model similar to the ICAPM arises, even with all agents behaving myopically. Empirically, fund flows obey a strong factor structure with the common component earning a risk premium, and fund portfolios are, on average, tilted toward low-flow-beta stocks. This tilt increases in magnitude when flow-hedging motives strengthen following natural disasters and unexpected trade-war announcements.