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Career Concerns in Financial Markets

  • Andrea Prat
  • Amil Dasgupta

    ()

What are the equilibrium features of a market where a sizeable portion of traders face career concerns? This question is central to our understanding of Þnancial markets that 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 we embed it into an asset pricing set-up. 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.� As churning plays the role of noise trading, the asset market displays non-fully informative prices and positive (and high) 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.

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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number dp494.

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Date of creation: May 2004
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Handle: RePEc:fmg:fmgdps:dp494
Contact details of provider: Web page: http://www.lse.ac.uk/fmg/

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  1. Robert Gibbons & Kevin J. Murphy, 1991. "Optimal Incentive Contracts in the Presence of Career Concerns: Theory and Evidence," NBER Working Papers 3792, National Bureau of Economic Research, Inc.
  2. Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
  3. Bengt Holmstrom & I. Ricard & Joan Costa, 1984. "Managerial Incentives and Capital Management," Cowles Foundation Discussion Papers 729, Cowles Foundation for Research in Economics, Yale University.
  4. Judith Chevalier & Glenn Ellison, 1998. "Career Concerns of Mutual Fund Managers," NBER Working Papers 6394, National Bureau of Economic Research, Inc.
  5. Franklin Allen, 2001. "Do Financial Institutions Matter?," Center for Financial Institutions Working Papers 01-04, Wharton School Center for Financial Institutions, University of Pennsylvania.
  6. Franklin Allen, 2001. "Presidential Address: Do Financial Institutions Matter?," Journal of Finance, American Finance Association, vol. 56(4), pages 1165-1175, 08.
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  8. 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.
  9. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
  10. Allen, Franklin & Gorton, Gary, 1993. "Churning Bubbles," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 813-36, October.
  11. Scharfstein, David. & Stein, Jeremy C., 1988. "Herd behavior and investment," Working papers WP 2062-88., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  12. Trueman, Brett, 1988. " A Theory of Noise Trading in Securities Markets," Journal of Finance, American Finance Association, vol. 43(1), pages 83-95, March.
  13. Ippolito, Richard A, 1992. "Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry," Journal of Law and Economics, University of Chicago Press, vol. 35(1), pages 45-70, April.
  14. Edwin J. Elton & Martin J. Gruber & Christopher R. Blake, 2003. "Incentive Fees and Mutual Funds," Journal of Finance, American Finance Association, vol. 58(2), pages 779-804, 04.
  15. 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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