The Social Dynamics of Performance
80 Pages Posted: 12 Jun 2012 Last revised: 26 Oct 2012
Date Written: September 13, 2012
A pervasive empirical finding is that mutual fund managers do not maintain their performance. In this paper, I show that social interactions can explain this fact. To do so, I allow a “crowd” of managers to meet at random times and exchange ideas within a rational-expectations equilibrium model. I show that social interactions simultaneously allow prices to become more efficient and better-informed managers to reap larger profits. Yet, social interactions cause managers’ alpha to become insignificant. The main implication is that increased efficiency causes managers to implement passive investment strategies for which they should not be rewarded. In addition, by increasing price informativeness, social interactions produce momentum in stock returns and induce most managers to become momentum traders, consistent with empirical findings.
Keywords: rational-expectations equilibrium, information percolation, social interactions, performance measure, performance persistence, momentum
JEL Classification: D53, D82, D83, D85, G14, G23
Suggested Citation: Suggested Citation