Journal
JOURNAL OF FINANCE
Volume 75, Issue 3, Pages 1715-1765Publisher
WILEY
DOI: 10.1111/jofi.12888
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Funding
- CORCLR Awards
- National Natural Science Foundation of China [71973002]
- Key Laboratory of Mathematical Economics and Quantitative Finance (Peking University), Ministry of Education of China
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We propose a theory of reputation to explain how investors rationally respond to mutual fund star ratings. A fund's performance is determined by its information advantage, which can be acquired but decays stochastically. Investors form beliefs about whether the fund is informed based on its past performance. We refer to such beliefs as fund reputation, which determines fund flows. As performance changes continuously, equilibrium fund reputation may take discrete values only and thus can be labeled with stars. Star upgrades thus imply reputation jumps, leading to discrete increases in flows and expected performance, although stars do not provide new information.
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