Dumb and Dumber: A Study of Capital Flows and Cross-sectional Mispricing

Sammanfattning: This study analyzes the role of smart money and dumb money in relation to cross-sectional mispricing of stocks, measured using eleven well-documented asset pricing anomalies. Further, we investigate whether dumber money is present in the market by examining the relationship between retail investor capital flows and mispricing in the cross section of stocks. We find that mutual fund flows exacerbate aggregate mispricing by buying overvalued stocks, while hedge fund flows attenuate aggregate mispricing. However, the price-correcting effect of hedge fund flows has diminished over time. Finally, our results suggest that retail investor capital flows represent dumber money, as the flows exacerbate aggregate mispricing from two ends: both by buying overvalued stocks and by selling undervalued stocks.