Fund Managers, Career Concerns, and Asset Price Volatility
41 Pages Posted: 25 Jul 2011
Date Written: July 25, 2011
We propose a model of delegated portfolio management with career concerns. Investors hire fund managers to invest their capital either in risky bonds or in riskless assets. Some managers have superior information on the default risk. Looking at the past performance, investors update beliefs on their managers and make firing decisions. This leads to career concerns which affect investment decisions, generating a counter-cyclical 'reputational premium'. When default risk is high, the bond’s return is high to compensate uninformed managers for the high risk of being fired. As default risk changes over time, the reputational premium amplifies price volatility.
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