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Money doctors

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  • Nicola Gennaioli
  • Andrei Shleifer
  • Robert Vishny

Abstract

We present a new model of money management, in which investors delegate portfolio management to professionals based not only on performance, but also on trust. Trust in the manager reduces an investor's perception of the riskiness of a given investment, and allows managers to charge higher fees to investors who trust them more. Money managers compete for investor funds by setting their fees, but because of trust the fees do not fall to costs. In the model, 1) managers consistently underperform the market net of fees but investors still prefer to delegate money management to taking risk on their own, 2) fees involve sharing of expected returns between managers and investors, with higher fees in riskier products, 3) managers pander to investors when investors exhibit biases in their beliefs, and do not correct misperceptions, and 4) despite long run benefits from better performance, the profits from pandering to trusting investors discourage managers from pursuing contrarian strategies relative to the case with no trust. We show how trust-mediated money management renders arbitrage less effective, and may help destabilize financial markets.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 1355.

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Date of creation: Jun 2012
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Handle: RePEc:upf:upfgen:1355

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  1. Veronica Guerrieri & Peter Kondor, 2010. "Fund managers, career concerns, and asset price volatility," Staff Report 446, Federal Reserve Bank of Minneapolis.
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  3. Sendhil Mullainathan & Markus Noeth & Antoinette Schoar, 2012. "The Market for Financial Advice: An Audit Study," NBER Working Papers 17929, National Bureau of Economic Research, Inc.
  4. Javier Gil-Bazo & Pablo Ruiz-Verd�, 2009. "The Relation between Price and Performance in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 64(5), pages 2153-2183, October.
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  16. Frazzini, Andrea & Lamont, Owen A., 2008. "Dumb money: Mutual fund flows and the cross-section of stock returns," Journal of Financial Economics, Elsevier, vol. 88(2), pages 299-322, May.
  17. Michael D. Hurd & Susann Rohwedder, 2012. "Stock Price Expectations and Stock Trading," NBER Working Papers 17973, National Bureau of Economic Research, Inc.
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Cited by:
  1. Thomas M. Eisenbach & Martin C. Schmalz, 2013. "Up close it feels dangerous: 'anxiety' in the face of risk," Staff Reports 610, Federal Reserve Bank of New York.

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