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Cited by 772Financial Markets and Investment StrategiesFinancial Analysis and Corporate GovernanceStock Market Forecasting Methods

A Flow-Based Explanation for Return Predictability

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Lou, Dong·2012·Review of Financial Studies
DOI 10.1093/rfs/hhs103
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Abstract

I propose and test a capital-flow-based explanation for some well-known empirical regularities concerning return predictability—the persistence of mutual fund performance, the “smart money” effect, and stock price momentum. First, I construct a measure of demand shocks to individual stocks by aggregating flow-induced trading across all mutual funds, and document a significant, temporary price impact of such uninformed trading. Next, given that mutual fund flows are highly predictable, I show that the expected part of flow-induced trading positively forecasts stock and mutual fund returns in the following year, which are then reversed in subsequent years. The main findings of the paper are that the flow-driven return effect can fully account for mutual fund performance persistence and the smart money effect, and can partially explain stock price momentum.

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  • Pre-crash liquidity levels proxy for frictions that may keep managers from choosing their optimal portfolios.

    “Pre-crash liquidity levels may have helped funds respond differently to the crisis(Chernenko and Sunderam (2016)), while at the same time, they proxy for frictions that may keep managers from choosing their optimal portfolios(Lou (2012)).”

    From Mutual Fund Trading, Fund Flows, and ESG Portfolios (2026) · cites this paper as Lou (2012)

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Research works printed but not linked: 42

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Authors
Lou, D.
Affiliations
Columbia University (US)
Corresponding author
Lou, Dong
ORCID
Lou, Dong
Venue
Review of Financial Studies
Publisher
Oxford University Press (OUP)
Published
2012-10-08
Volume
25
Issue
12
Pages
3457-3489
ISSN
  • 0893-9454 (ISSN-L)
  • 1465-7368
DOI
10.1093/rfs/hhs103
OpenAlex
W2235373759
Cited by
772
References
2
Citations by year
2026: 73 · 2025: 87 · 2024: 62 · 2023: 65 · 2022: 67 · 2021: 65 · 2020: 51 · 2019: 37 · 2018: 39 · 2017: 30 · 2016: 45 · 2015: 33 · 2014: 30 · 2013: 22 · 2012: 21
FWCI
56.33
Type
journal article
Language
en
Open access
Locations
  • Review of Financial Studies (publishedVersion)
  • SSRN Electronic Journal (acceptedVersion)
  • London School of Economics and Political Science Research Online (London School of Economics and Political Science) (acceptedVersion)
  • RePEc: Research Papers in Economics (submittedVersion)
  • London School of Economics and Political Science Theses Online (London School of Economics and Political Science) (submittedVersion)
  • Rare & Special e-Zone (The Hong Kong University of Science and Technology) (submittedVersion)
Topics
  • Social Sciences › Economics, Econometrics and Finance › Finance › Financial Markets and Investment Strategies
  • Social Sciences › Business, Management and Accounting › Accounting › Financial Analysis and Corporate Governance
  • Social Sciences › Decision Sciences › Management Science and Operations Research › Stock Market Forecasting Methods
Keywords
return predictability, capital flows, mutual fund flows, price impact, smart money effect, stock price momentum, demand shocks

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