Abstract: I study whether mutual fund managers intentionally adopt negatively skewed strategies to generate superior performance. Using the fund flow and return data of U.S. actively managed equity funds from 1999 to 2014, I identify a negative correlation between alpha and the third moment (skewness) of the fund return distribution. The average difference of the Carhart four-factor alpha between funds in the lowest and highest skewness decile portfolio is 5.28% per year. Then, I examine whether fund investors pay attention to return skewness when choosing among actively managed mutual funds. My empirical evidence suggests that fund investors are not sophisticated enough to detect the trade-off between alpha and skewness; many simply invest in mutual funds with superior performance without taking into account the potential downside risk. Consequently, the managerial incentive problem has been raised. Without having to improve their forecasting skills, mutual fund managers can still generate flow-attracting strategies by loading on more downside risk. Specifically, as their compensation is determined by relative performance, fund managers that deliver inferior performance in the first half-year are more likely to increase downside risk in the second half-year than interim winners. This tendency is more prominent among small and growth funds.

Discussant: Yuxi Wang, Shanghai Jiao Tong University

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  Chole Chunliu Yang

  FISF

Abstract: This paper develops a framework to conduct the first formal comparison of two main approaches (the traditional tax reform approach and the recently developed bunching approach) to estimate the elasticity of taxable income (ETI), a central parameter in the public finance literature since Feldstein (1999). Using a novel panel of administrative personal income tax data from China and exploiting China’s progressive monthly wage income tax schedule and a tax reform in 2011, we document two key differences between the ETI estimates using two approaches. First, the tax reform ETI estimates increase concavely over time, while the bunching ETI estimates are much more stable. Second, the tax reform ETI estimates (around 4 in the long-run) are much larger than the bunching ETI (around 0.5), and the difference is statistically significant. These stylized facts imply that very different behavioral responses are captured by the two approaches. To account for the stylized facts, we develop a simple model where individuals in each period have some probability to permanently change hours of work without paying other costs but can temporarily adjust hours by paying additional costs. With stable wage rates, the two estimators should converge to the same underlying value. But with normal wage growth, the tax reform estimates converge to the true underlying parameter, whereas the bunching estimates can be far below the true figure. The findings imply that although the bunching approach has advantages in identification and application, the tax reform ETI estimates are generally more relevant for policy making due to the behavioral responses they are able to capture.

Discussant: Zhikuo Liu, Shanghai University of Finance and Economics

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  Xiaxin Wang

  FISF