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Overconfidence and Delegated Portfolio Management

  • Palomino, Frédéric
  • Sadrieh, Abdolkarim

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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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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  1. Gervais, Simon & Odean, Terrance, 2001. "Learning to be Overconfident," Review of Financial Studies, Society for Financial Studies, vol. 14(1), pages 1-27.
  2. Hackbarth, Dirk, 2008. "Managerial Traits and Capital Structure Decisions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 43(04), pages 843-881, December.
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  8. Heath, Chip & Tversky, Amos, 1991. " Preference and Belief: Ambiguity and Competence in Choice under Uncertainty," Journal of Risk and Uncertainty, Springer, vol. 4(1), pages 5-28, January.
  9. Susan I. Cohen & Laura T. Starks, 1988. "Estimation Risk and Incentive Contracts for Portfolio Managers," Management Science, INFORMS, vol. 34(9), pages 1067-1079, September.
  10. James Dow & Gary Gorton, . "Noise Trading, Delegated Portfolio Management, and Economic Welfare," Rodney L. White Center for Financial Research Working Papers 19-94, Wharton School Rodney L. White Center for Financial Research.
  11. Admati, Anat R & Pfleiderer, Paul, 1997. "Does It All Add Up? Benchmarks and the Compensation of Active Portfolio Managers," The Journal of Business, University of Chicago Press, vol. 70(3), pages 323-50, July.
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  17. Terrance Odean, 1998. "Volume, Volatility, Price, and Profit When All Traders Are Above Average," Journal of Finance, American Finance Association, vol. 53(6), pages 1887-1934, December.
  18. Pütz, Alexander & Ruenzi, Stefan, 2009. "Overconfidence among professional investors: Evidence from mutual fund managers," CFR Working Papers 08-08, University of Cologne, Centre for Financial Research (CFR).
  19. Terrance Odean, 1998. "Volume, Volatility, Price and Profit When All Traders Are Above Average," Finance 9803001, EconWPA.
  20. J. Bradford De Long & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, . "Noise Trader Risk in Financial Markets," J. Bradford De Long's Working Papers _124, University of California at Berkeley, Economics Department.
  21. KENT D. DANIEL & David Hirshleifer & AVANIDHAR SUBRAHMANYAM, 2004. "A Theory of Overconfidence, Self-Attribution, and Security Market Under- and Over-reactions," Finance 0412006, EconWPA.
  22. Caballe, Jordi & Sakovics, Jozsef, 2003. "Speculating against an overconfident market," Journal of Financial Markets, Elsevier, vol. 6(2), pages 199-225, April.
  23. Peter Diamond, 1998. "Managerial Incentives: On the Near Linearity of Optimal Compensation," Journal of Political Economy, University of Chicago Press, vol. 106(5), pages 931-957, October.
  24. Wang, F. Albert, 2001. "Overconfidence, Investor Sentiment, and Evolution," Journal of Financial Intermediation, Elsevier, vol. 10(2), pages 138-170, April.
  25. Easley, David & O'Hara, Maureen, 1987. "Price, trade size, and information in securities markets," Journal of Financial Economics, Elsevier, vol. 19(1), pages 69-90, September.
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  27. Palomino, Frederic, 1996. " Noise Trading in Small Markets," Journal of Finance, American Finance Association, vol. 51(4), pages 1537-50, September.
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