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Financial equilibrium with career concerns

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    (LSE)

  • ,

    (LSE)

Abstract

What are the equilibrium features of a financial market where a sizeable proportion of traders face reputational concerns? This question is central to our understanding of financial markets, which are increasingly dominated by institutional investors. We construct a model of delegated portfolio management that captures key features of the US mutual fund industry and embed it in an asset pricing framework. We thus provide a formal model of financial equilibrium with career concerned agents. Fund managers differ in their ability to understand market fundamentals, and in every period investors choose a fund. In equilibrium, the presence of career concerns induces uninformed fund managers to churn , i.e., to engage in trading even when they face a negative expected return. Churners act as noise traders and enhance the level of trading volume. The equilibrium relationship between fund return and net fund flows displays a skewed shape that is consistent with stylized facts. The robustness of our core results is probed from several angles.

Suggested Citation

  • , & ,, 2006. "Financial equilibrium with career concerns," Theoretical Economics, Econometric Society, vol. 1(1), pages 67-93, March.
  • Handle: RePEc:the:publsh:165
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    File URL: http://econtheory.org/ojs/index.php/te/article/viewFile/20060067/447/11
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    More about this item

    Keywords

    Career concerns; financial equilibrium; trade volume;
    All these keywords.

    JEL classification:

    • G0 - Financial Economics - - General
    • C7 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory

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