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Financial equilibrium with career concerns

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Author(s): Amil Dasgupta | Andrea Prat

Journal: Theoretical Economics
ISSN 1555-7561

Volume: 1;
Issue: 1;
Date: 2006;
Original page

Keywords: Career concerns | financial equilibrium | trade volume | G0 | C7

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.
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