Risk Return Relationship And Return Persistence In The Worst Performing Funds

In recent years, as increasing in variety, quantity and the diversification of investment style of mutual fund, the group of mutual fund investors enlarges rapidly. Mutual fund has become the most important institutional investor as its increasing scale and increasing standardized operations. What is the relationship between risk and return? Is high risk accompanied by high return? How does fund past performance affect fund managers' risk attitudes? Is the worst performing funds risk seeking? How can their risk attitudes affect the return persistence? All of these questions are deserved further research.Traditional finance theory hypothesizes that the relationship between risk and return is positive. High risk is accompanied with high return, and vise verse. However, in Strategic Management area, some firms have both high risk and low profit, while others have both low risk and high profit. After studying on the Financial Anomalies, researchers found the "risk-return paradox" in companies. Besides, researchers also found "risk-return paradox" in capital market. These can not be explained by conventional finance theory. However, behavioral finance and the "Prospect Theory" explain this "paradox" well by using psychology theory. According to the "Prospect Theory", there always exists a reference point when investors make decisions. People treat performance under the point as a loss and performance above the point as a gain. They are risk seeking in choices involving losses and risk aversion in choices involving gains. So the risk-return relationship is expected to be negative below reference point and positive above reference point.The following are the main contents of this article:Firstly, this paper introduces the traditional hypothesis of risk-return relationship, including Efficient Market Hypothesis, Expected Utility Theory and the Modern Portfolio Theory. Then we introduce the new decision theory under risk——prospect theory, which explains the "finance anomalies" well. This part provides solid theoretical foundation to the below contents of the text.Secondly, I use the method of empirical research to study risk-return relationship and whether the worst performing funds have more risk. First of all, this part of the evidence outlines a variety of parameters selected in the study, including the funds'risk and yield indicator, the performance indicator, the choice of risk-free interest and the benchmark of performance evaluation. Secondly, we introduce the research methods. Finally, we give the empirical test and result analysis. We introduce risk indicator——ES, and construct indicator——ER to measure fund performance. While examining risk-return relationship, we use contingency table analysis and Spearman rank order correlation coefficients. When comparing the difference of risk between funds performing worst and best, we use t-test. The results are as follows:first, the risk-return relationship is significantly positive except the year-2008, which is the "big bear" and risk-return relationship is significantly negative. So, there isn't "risk-return paradox" in our mutual fund market. Secondly, in the normal market, funds with bad performance have more risk than funds with good performance and vise versa when market environment is terrible.Thirdly, we give the empirical test of risk seeking behaviors' influence on performance persistence. Based on the conclusion of the third part, we assume funds'risk seeking behavior doesn't bring high return, which lead to the persistence of bad performance. We take one year for assessment period and the following year for holding period. Using the same performance indicators, we rank and group all the funds by their performance. The result is:although we can't prove whether there is performance persistence in the best and common funds, there is performance persistence in the worst performing funds.