Time-Varying Loss Aversion of Mutual Fund Managers as a Response to Incentives

Using detailed mutual fund holdings in the US market, we estimate active mutual fund managers’ loss aversion as a function of both funds’ past performance and asset allocations. We document a substantial variation in loss aversion over time. We further find managers' loss aversion is higher when past fund flows were high and lower when past fund flows were lower. This positive loss aversion-flow relationship is more pronounced among funds with net outflows, larger size, more illiquid positions, or more growth-oriented positions. We offer novel evidence to support the tournament effect, indicating that managers compete for greater inflows strategically while exhibiting self-interested choices