Prospect Theory and Mutual Fund Flows : Evidence from China

Using a sample of Chinese mutual funds over the 2007–2021 period, we explore whether prospect theory (PT) can accurately portray the risk preferences and behavior of Chinese fund investors. We find a significant positive relationship between the fund-level PT value and future flows. After controlling for other lottery-type characteristics of fund returns, various characteristics of funds and fund families, and the convexity of the flow-performance relationship, the relationship remains robust. Moreover, investors' preference for lottery-type characteristics of PT values rather than increased fund visibility induces net fund inflows. The flow-PT relationship is stronger when fund visibility is high. Further, PT values positively and significantly predict future fund performance and skills. In the Chinese market, the flow-PT relationship is present among individual and institutional investors. Hence, we further expand the application scope and operation mechanism of PT, providing a Chinese perspective on its application