MUTUAL FUNDS, PART II - FUND FLOWS AND SECURITY RETURNS

Mutual funds played a very small role in the financial system until th e 1970s, before which ownership of financial instruments was dominated by commercial banks, thrift institutions, insurance companies, and pe nsion funds. The financial system of the 1990s is not simply the syste m of the 1970s with more mutual funds, however. Evolution in financial laws and regulations, increasing global interactions, the rise of new financial instruments, major shifts in the structure and nature of fi nancial institutions, and a change in the locus of risk-bearing from i nstitutions to individuals have also shaped investors' decisions. The goal of this study is to assess the historical evidence to see whether the interactions between mutual fund inflows and outflows and asset p rices are potentially destabilizing to security markets. The author ad dresses some issues of shareholder behavior and the differences betwee n direct ownership and pooled ownership of securities. He presents an econometric analysis of the interactions between security returns and mutual fund flows, and he uses his model to trace out the effect of sh ocks to security returns and fund flows. In contrast to previous studi es, he finds that security returns do affect future fund flows, and th at some fund flows do affect future security returns. But he finds no persistence in security returns-shocks to, say, stock returns do not i mply further changes in stock returns, so the rationale for momentum t rading over longer period finds no support.