Revealed Preferences of Mutual Fund Investors in Good and Bad Times

Recent works demonstrate that the Capital Asset Pricing Model (CAPM) alpha is most likely used by investors as the performance measure in mutual fund. I explore the validity of this claim in different market conditions and show that the CAPM is only preferred by investors in good times, but it fails against the simple model (fund return minus market return) in bad times. Fund characteristics and investor sophistication cannot explain the pattern. The time-varying fund flow sensitivity to different fund performance components matters. Decomposing the fund return measured by this simple model into the CAPM alpha and a component proxy for market timing performance, I find that the fund flow sensitivity to market timing performance is countercyclical