Do Mutual Fund Investors Overweight the Probability of Extreme Payoffs in the Return Distribution?

We investigate the role of extreme positive payoffs in the distribution of monthly fund returns on investors’ mutual fund preferences. We document a positive and significant relation between the maximum style-adjusted monthly return (MAX) over the previous year’s monthly returns and future fund flows. Our findings are consistent with the idea that fund investors overweight the probability of high payoff states in past return distribution. MAX as a measure of average past fund performance, increase in fund visibility, convex performance-flow relation, underlying stocks’ extreme returns, and MAX as a metric of future performance do not explain our results