IDEAS home Printed from https://ideas.repec.org/a/aea/jecper/v27y2013i2p29-50.html
   My bibliography  Save this article

Finance: Function Matters, Not Size

Author

Listed:
  • John H. Cochrane

Abstract

It's fun to pass judgment on waste, size, usefulness, complexity, and excessive compensation. But as economists, we have an analytical structure for thinking about these questions. "I don’t understand it" doesn't mean "it's bad," or "regulation will improve it." That attitude pervades policy analysis in general and financial regulation in particular, and economists do the world a disservice if we echo it. I will not offer a competing black box [to explain the size of the finance industry]. I don’t claim to estimate the socially optimal "size of finance" at, say, 8.267 percent of GDP. It's just the wrong question. Hayek and the failure of planning should teach us a little modesty: Pronouncing on socially optimal industry size is a waste of time. Is the finance industry functioning well? Are there identifiable market or government distortions? Will proposed regulations help or make matters worse? These are useful questions.

Suggested Citation

  • John H. Cochrane, 2013. "Finance: Function Matters, Not Size," Journal of Economic Perspectives, American Economic Association, vol. 27(2), pages 29-50, Spring.
    • Handle: RePEc:aea:jecper:v:27:y:2013:i:2:p:29-50
    Note: DOI: 10.1257/jep.27.2.29
    as

    Download full text from publisher

    File URL: http://www.aeaweb.org/articles.php?doi=10.1257/jep.27.2.29
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Acharya, Viral V. & Pedersen, Lasse Heje, 2005. "Asset pricing with liquidity risk," Journal of Financial Economics, Elsevier, vol. 77(2), pages 375-410, August.
    2. Kenneth R. French, 2008. "Presidential Address: The Cost of Active Investing," Journal of Finance, American Finance Association, vol. 63(4), pages 1537-1573, August.
    3. Owen A. Lamont & Richard H. Thaler, 2003. "Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outs," Journal of Political Economy, University of Chicago Press, vol. 111(2), pages 227-268, April.
    4. Carhart, Mark M, 1997. "On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    5. David O. Lucca & Emanuel Moench, 2015. "The Pre-FOMC Announcement Drift," Journal of Finance, American Finance Association, vol. 70(1), pages 329-371, February.
    6. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
    7. Cochrane, John H, 1991. "Production-Based Asset Pricing and the Link between Stock Returns and Economic Fluctuations," Journal of Finance, American Finance Association, vol. 46(1), pages 209-237, March.
    8. John H. Cochrane, 2011. "Discount Rates," NBER Working Papers 16972, National Bureau of Economic Research, Inc.
    9. Kim, O & Verrecchia, Re, 1991. "Trading Volume And Price Reactions To Public Announcements," Journal of Accounting Research, Wiley Blackwell, vol. 29(2), pages 302-321.
    10. Jonathan B. Berk & Richard C. Green, 2004. "Mutual Fund Flows and Performance in Rational Markets," Journal of Political Economy, University of Chicago Press, vol. 112(6), pages 1269-1295, December.
    11. Merton, Robert C., 1971. "Optimum consumption and portfolio rules in a continuous-time model," Journal of Economic Theory, Elsevier, vol. 3(4), pages 373-413, December.
    12. Fama, Eugene F & French, Kenneth R, 1996. "Multifactor Explanations of Asset Pricing Anomalies," Journal of Finance, American Finance Association, vol. 51(1), pages 55-84, March.
    13. William N. Goetzmann & Sharon Oster, 2013. "Competition among University Endowments," NBER Chapters, in: How the Financial Crisis and Great Recession Affected Higher Education, pages 99-126, National Bureau of Economic Research, Inc.
    14. Hirshleifer, Jack, 1971. "The Private and Social Value of Information and the Reward to Inventive Activity," American Economic Review, American Economic Association, vol. 61(4), pages 561-574, September.
    15. John H. Cochrane, 2011. "Presidential Address: Discount Rates," Journal of Finance, American Finance Association, vol. 66(4), pages 1047-1108, August.
    16. Jonathan B. Berk & Jules H. van Binsbergen, 2012. "Measuring Managerial Skill in the Mutual Fund Industry," NBER Working Papers 18184, National Bureau of Economic Research, Inc.
    17. Eugene F. Fama & Kenneth R. French, 2010. "Luck versus Skill in the Cross‐Section of Mutual Fund Returns," Journal of Finance, American Finance Association, vol. 65(5), pages 1915-1947, October.
    18. Brad M. Barber & Yi-Tsung Lee & Yu-Jane Liu & Terrance Odean, 2009. "Just How Much Do Individual Investors Lose by Trading?," The Review of Financial Studies, Society for Financial Studies, vol. 22(2), pages 609-632, February.
    19. Snehal Banerjee & Ilan Kremer, 2010. "Disagreement and Learning: Dynamic Patterns of Trade," Journal of Finance, American Finance Association, vol. 65(4), pages 1269-1302, August.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Guiso, Luigi & Sodini, Paolo, 2013. "Household Finance: An Emerging Field," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1397-1532, Elsevier.
    2. Savov, Alexi, 2014. "The price of skill: Performance evaluation by households," Journal of Financial Economics, Elsevier, vol. 112(2), pages 213-231.
    3. Committee, Nobel Prize, 2013. "Understanding Asset Prices," Nobel Prize in Economics documents 2013-1, Nobel Prize Committee.
    4. Joseph Gerakos & Juhani T. Linnainmaa & Adair Morse, 2016. "Asset Managers: Institutional Performance and Smart Betas," NBER Working Papers 22982, National Bureau of Economic Research, Inc.
    5. Brown, Stephen J. & Sotes-Paladino, Juan & Wang, Jiaguo(George) & Yao, Yaqiong, 2017. "Starting on the wrong foot: Seasonality in mutual fund performance," Journal of Banking & Finance, Elsevier, vol. 82(C), pages 133-150.
    6. Mateus, Irina B. & Mateus, Cesario & Todorovic, Natasa, 2019. "Review of new trends in the literature on factor models and mutual fund performance," International Review of Financial Analysis, Elsevier, vol. 63(C), pages 344-354.
    7. Chang, Xiaochen & Guo, Songlin & Huang, Junkai, 2022. "Kidnapped mutual funds: Irrational preference of naive investors and fund incentive distortion," International Review of Financial Analysis, Elsevier, vol. 83(C).
    8. Babalos, Vassilios & Caporale, Guglielmo Maria & Philippas, Nikolaos, 2012. "Efficiency evaluation of Greek equity funds," Research in International Business and Finance, Elsevier, vol. 26(2), pages 317-333.
    9. Li, Zhiyong & Rao, Xiao, 2023. "Exploring the zoo of predictors for mutual fund performance in China," Pacific-Basin Finance Journal, Elsevier, vol. 77(C).
    10. Daniel, Kent & Hirshleifer, David & Teoh, Siew Hong, 2002. "Investor psychology in capital markets: evidence and policy implications," Journal of Monetary Economics, Elsevier, vol. 49(1), pages 139-209, January.
    11. Nicolae Gârleanu & Lasse Heje Pedersen, 2018. "Efficiently Inefficient Markets for Assets and Asset Management," Journal of Finance, American Finance Association, vol. 73(4), pages 1663-1712, August.
    12. Elton, Edwin J. & Gruber, Martin J., 2013. "Mutual Funds," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, volume 2, chapter 0, pages 1011-1061, Elsevier.
    13. Blankespoor, Elizabeth & deHaan, Ed & Marinovic, Iván, 2020. "Disclosure processing costs, investors’ information choice, and equity market outcomes: A review," Journal of Accounting and Economics, Elsevier, vol. 70(2).
    14. Amit Goyal, 2012. "Empirical cross-sectional asset pricing: a survey," Financial Markets and Portfolio Management, Springer;Swiss Society for Financial Market Research, vol. 26(1), pages 3-38, March.
    15. Habib, Michel & Johnsen, D. Bruce, 2015. "The quality-assuring role of mutual fund advisory fees," CEPR Discussion Papers 10438, C.E.P.R. Discussion Papers.
    16. Sotes-Paladino, Juan & Zapatero, Fernando, 2022. "Carrot and stick: A role for benchmark-adjusted compensation in active fund management," Journal of Financial Intermediation, Elsevier, vol. 52(C).
    17. Pástor, Ľuboš & Stambaugh, Robert F. & Taylor, Lucian A., 2015. "Scale and skill in active management," Journal of Financial Economics, Elsevier, vol. 116(1), pages 23-45.
    18. Habib, Michel A. & Johnsen, D. Bruce, 2016. "The quality-assuring role of mutual fund advisory fees," International Review of Law and Economics, Elsevier, vol. 46(C), pages 1-19.
    19. Campbell R. Harvey & Yan Liu & Heqing Zhu, 2014. ". . . and the Cross-Section of Expected Returns," NBER Working Papers 20592, National Bureau of Economic Research, Inc.
    20. Rui J. P. de Figueiredo, Jr. & Evan Rawley, 2011. "Skill, Luck, and the Multiproduct Firm: Evidence from Hedge Funds," Management Science, INFORMS, vol. 57(11), pages 1963-1978, November.

    More about this item

    JEL classification:

    • E23 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Production
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:aea:jecper:v:27:y:2013:i:2:p:29-50. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Michael P. Albert (email available below). General contact details of provider: https://edirc.repec.org/data/aeaaaea.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.