Prospect Theory and Fund Flows under Uncertainty

Abstract

We study whether macroeconomic uncertainty attenuates investors’ behavioural demand for mutual funds. This study employs a comprehensive dataset of U.S. equity mutual funds covering the period from 1995 to 2021. Using monthly panel regressions that incorporate fund-specific fixed effects and double-clustered standard errors at both the fund and time levels, we examine how future fund flows respond to a Cumulative Prospect Theory (CPT) score. The CPT measure is derived from the complete distribution of each fund’s returns over the preceding twelve months. A one-standard-deviation increase in CPT predicts higher inflows, but this CPT–flow sensitivity weakens meaningfully when Economic Policy Uncertainty (EPU) rises (about a 15% attenuation in our baseline), even after controlling for risk-adjusted performance and factor exposures. The dampening is strongest for younger, smaller, high idiosyncratic-volatility, and high downside-risk funds, and for active and local funds. Replacing EPU with alternative uncertainty proxies reveals distinct mechanisms: looser global financial conditions (higher GFC) amplify CPT- and return-driven flows; a tighter shadow rate lowers average flows yet increases selectivity toward CPT-aligned funds; and quantitative easing boosts baseline flows while eroding the marginal CPT premium. Results are robust when using abnormal returns and when focusing on “high” CPT/return funds (above the monthly median), for which premia are economically larger but similarly state-dependent. These findings integrate behavioural portfolio choice with macro-uncertainty channels and map when performance-chasing is most fragile.