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Mutual Funds and Bubbles: The Surprising Role of Contractual Incentives

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  • Nishant Dass
  • Massimo Massa
  • Rajdeep Patgiri
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    Abstract

    This article studies one of the potential causes of the financial market bubble of the late 1990s: the herding behavior of mutual funds. We show that the incentives contained in the mutual funds' advisory contracts induce managers to overcome their tendency to herd. We argue that investing in bubble stocks amounts to herding and contracts with high incentives induce managers to diverge from the herd, thus reducing their holding of bubble stocks. The differential exposure to bubble stocks significantly impacted the funds' performance both in the period prior to March 2000, as well as afterwards. The Author 2007. Published by Oxford University Press on behalf of The Society for Financial Studies., Oxford University Press.

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    File URL: http://hdl.handle.net/10.1093/rfs/hhm033
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    Bibliographic Info

    Article provided by Society for Financial Studies in its journal The Review of Financial Studies.

    Volume (Year): 21 (2008)
    Issue (Month): 1 (January)
    Pages: 51-99

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    Handle: RePEc:oup:rfinst:v:21:y:2008:i:1:p:51-99

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    Cited by:
    1. Amil Dasgupta & Andrea Prat & Michela Verardo, 2011. "The Price Impact of Institutional Herding," Review of Financial Studies, Society for Financial Studies, vol. 24(3), pages 892-925.
    2. David B. Brown & Enrico G. De Giorgi & Melvyn Sim, 2009. "A Satisficing Alternative to Prospect Theory," University of St. Gallen Department of Economics working paper series 2009 2009-09, Department of Economics, University of St. Gallen.
    3. Englmaier, Florian & Filipi, Ales & Singh, Ravi, 2010. "Incentives, reputation and the allocation of authority," Journal of Economic Behavior & Organization, Elsevier, vol. 76(2), pages 413-427, November.
    4. Robin Greenwood & Stefan Nagel, 2008. "Inexperienced Investors and Bubbles," NBER Working Papers 14111, National Bureau of Economic Research, Inc.
    5. Li Lin & Didier Sornette, 2009. "Diagnostics of Rational Expectation Financial Bubbles with Stochastic Mean-Reverting Termination Times," Papers 0911.1921, arXiv.org.
    6. Vivek Singh, 2013. "Did institutions herd during the internet bubble?," Review of Quantitative Finance and Accounting, Springer, vol. 41(3), pages 513-534, October.
    7. Enrico G. De Giorgi, 2009. "Goal-Based Investing with Cumulative Prospect Theory and Satisficing Behavior," University of St. Gallen Department of Economics working paper series 2009 2009-22, Department of Economics, University of St. Gallen.
    8. Enrico G. De Giorgi & David B. Brown & Melvyn Sim, 2010. "Dual representation of choice and aspirational preferences," University of St. Gallen Department of Economics working paper series 2010 2010-07, Department of Economics, University of St. Gallen.

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