Reference-Dependent Preferences and Mutual Fund Flows

Despite the ability to explain many puzzling phenomena in financial markets, direct tests of reference-dependent preferences of Kahneman and Tversky (1979, 1992) have mainly been conducted in experimental settings. We propose a novel test based on revealed preferences of real-world investors. Following Berk and van Binsbergen (2016) and Barber, Huang, and Odean (2016), we use the well-documented mutual fund flow-performance relationship to examine if investors have different preferences over gains and losses when they evaluate performance. We infer investors' utility function from mutual fund flows instead of structurally estimating it with experimental or field data. We find that investors place a greater emphasis on losses than gains. Moreover, institutional investors always penalize risk, yet retail investors are risk-averse only over gains but risk-seeking over losses, inline with reference-dependent preferences rather than global risk aversion.