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The price of skill: Performance evaluation by households

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  • Savov, Alexi

Abstract

Skilled investors make money off uninformed investors. By acting as intermediaries, they provide a hedge to the uninformed investors themselves. I present a model in which households have imperfect information about expected returns. Non-traded income shocks lead them to rebalance, sometimes at the wrong time. Active funds hedge this risk by trading on superior information. In equilibrium, they pay off when non-traded income disappoints, earning a premium that makes them appear to underperform index funds after fees. Empirical results using aggregate fund flows support the model. A corresponding asset pricing test can account for the apparent underperformance of active funds.

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  • Savov, Alexi, 2014. "The price of skill: Performance evaluation by households," Journal of Financial Economics, Elsevier, vol. 112(2), pages 213-231.
    • Handle: RePEc:eee:jfinec:v:112:y:2014:i:2:p:213-231
    DOI: 10.1016/j.jfineco.2013.11.005
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    More about this item

    Keywords

    Mutual fund performance; Active funds; Index funds; Fund flows;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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