Opportunity Cost and Investor Behavior: Performance-Flow Relationship in Mutual Funds

This study investigates the impact of real interest rates on the performance-flow relationship (PFR) in mutual funds, highlighting the role of opportunity costs in investor decision-making. A 1% rise in real interest rates increases PFR by 0.365%, reflecting heightened investor sensitivity to past performance, particularly in actively managed funds and those delivering superior returns. Sub-group analyses confirm these findings: index funds exhibit weaker PFR responses due to their passive nature, institutional investors rely less on past performance under high-rate conditions, and value funds show lower performance sensitivity compared to growth funds. In contrast, retail investors are significantly more responsive to both regular and extreme returns. These results underscore how macroeconomic conditions shape capital allocation and offer insights for fund managers and policymakers navigating dynamic economic environments.