Investor Flows and Stock Market Returns

This study is the first to simultaneously analyze the relation between aggregate stock market returns and cash flows of the various investor groups that constitute the entire stock market in the United States. We examine the relation between investor flows and stock market returns over a long time period from 1952 to 2004, and also examine the relation between investor flows and longer-term stock market returns. Using a first-order VAR, we find strong evidence that flows can help forecast returns. When flows are added to regressions of stock market returns on lagged returns, dividend price ratios, and interest rates using non-overlapping annual data, the adjusted R-squared increases from 9 percent to 33 percent. We further document a significant and positive contemporaneous relation between stock market returns and flows of Mutual Funds and Foreign Investors, which is stronger during the post-1984 period when these investor groups are larger and more active. ∗We thank Sugato Bhattacharyya, Randolph Cohen, Kenneth French, William Goetzmann, Roger Ibbotson, Grant McQueen, Tyler Shumway, Clemens Sialm, Rene Stulz, Paula Tkac, Vincent Warther, Toni Whited, and seminar participants at the University of Michigan Business School, Brigham Young University, the Board of Governors of the Federal Reserve, and the American Finance Association meetings (2003) for useful comments. Contact information: Brian Boyer, Brigham Young University, Provo, UT-84602. Phone: 801-422-7641 ; e-mail: [email protected]; Lu Zheng, University of Michigan Business School, 701 Tappan St., Ann Arbor, MI-48109-1234. Phone: 734-763-5392; e-mail: [email protected].