Common Fund Flows in China: Flow Hedging and Factor Pricing

Abstract

This paper investigates a novel mechanism of common mutual fund risk within the Chinese stock market, demonstrating that fund managers strategically adjust their portfolios to hedge against shared fund flow risks. These adjustments significantly influence stock prices, highlighting the critical role of common fund risk in market behavior. Utilizing Principal Component Analysis (PCA), the study extracts a characteristic of common fluctuations among active mutual funds, referred to as "common mutual fund flow." It calculates each stock's exposure to risk within the portfolio, denoted as flow beta, and finds that the high-low price spreads of flow beta are significant after grouping. The analysis reveals that mutual fund managers in the Chinese market exhibit a strong sensitivity to common mutual fund flow risk and actively adjust their portfolios to mitigate this risk, showing a marked tendency to acquire more low-beta stocks. This paper offers methods and evidence to enhance the understanding of the principles governing the Chinese stock market and fund manager behaviors, thereby enriching the empirical evidence of intermediary asset pricing models in China.