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Overconfidence and Delegated Portfolio Management

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  • Palomino, Frédéric
  • Sadrieh, Abdolkarim

Abstract

Following extensive empirical evidence about ‘market anomalies’ and overconfidence, the analysis of financial markets with agents overconfident about the precision of their private information has received a lot of attention. All these models consider agents trading for their own account. In this article, we analyse a standard delegated portfolio management problem between a financial institution and a money manager who may be of two types: rational or overconfident. We consider several situations. In each case, we derive the optimal contract and results on the performance of financial institution hiring overconfident managers relative to institutions hiring rational agents, and results on the price impact of overconfidence.

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Bibliographic Info

Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 4231.

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Date of creation: Feb 2004
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Handle: RePEc:cpr:ceprdp:4231

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Keywords: optimal contract; overconfidence; risk-taking incentives;

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References

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  1. Terrance Odean, 1998. "Volume, Volatility, Price and Profit When All Traders Are Above Average," Finance 9803001, EconWPA.
  2. Dow, James & Gorton, Gary, 1997. "Noise Trading, Delegated Portfolio Management, and Economic Welfare," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1024-50, October.
  3. KENT D. DANIEL & David Hirshleifer & AVANIDHAR SUBRAHMANYAM, 2004. "A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions," Finance 0412006, EconWPA.
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  10. Kyle, Albert S & Wang, F Albert, 1997. " Speculation Duopoly with Agreement to Disagree: Can Overconfidence Survive the Market Test?," Journal of Finance, American Finance Association, vol. 52(5), pages 2073-90, December.
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Cited by:
  1. Wang, Jian & Sheng, Jiliang & Yang, Jun, 2013. "Optimism bias and incentive contracts in portfolio delegation," Economic Modelling, Elsevier, vol. 33(C), pages 493-499.

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