Do Investors Care About Tail Risk? Evidence from Mutual Fund Flows

Yong Chen is a Professor of Finance, the David R. Norcom’ 73 Endowed Professor, and Coordinator of the Finance Ph.D. Program at Mays Business School, Texas A&M University. Prior to joining Mays Business School in 2012, he was on the faculty of Virginia Tech. Dr. Chen received B.A. and M.A. in Economics from Nankai University and Ph.D. in Finance from Boston College. Dr. Chen’s research area is empirical asset pricing and investments with a focus on the interaction between the investment of hedge funds and the behavior of asset prices. His research has been published in leading academic journals including the Journal of Finance, the Journal of Financial Economics, the Review of Financial Studies, the Journal of Financial and Quantitative Analysis, and Management Science and practitioner journals including Financial Analysts Journal and the Journal of Investment Management, as well as presented at numerous university workshops, academic and practitioner conferences, financial policymakers, and hedge funds. His research has received several awards and grants, such as the Graham and Dodd Scroll Award from the CFA Institute and a research grant from the Q group. Dr. Chen has taught advanced investments, derivatives, portfolio management, and empirical asset pricing at the undergraduate, MBA, MSF, and doctoral levels.

This paper examines investor attitude toward tail risk based on mutual fund flows. We show that fund flows are significantly sensitive to tail risk in the cross-section, even after controlling for fund performance and characteristics. Using terrorist attacks and COVID-19 as exogenous shocks to the investor fear level, we find that fund flows become increasingly sensitive to tail risk following the shocks, suggesting that fear is a driving force of the tail risk aversion. In particular, the flow-tail risk sensitivity during the onset of COVID-19 is about 7-15 times larger than that in other periods. The results are robust to examining international funds and alternative measures of tail risk. Overall, our findings suggest that investors care about tail risk beyond traditional risks.