Noisy Active Management

46 Pages Posted: 22 Jun 2017 Last revised: 25 Jun 2017

See all articles by Robert F. Stambaugh

Robert F. Stambaugh

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Date Written: June 23, 2017

Abstract

Lower skill of the active management industry can imply greater fee revenue, value added, and investor performance. Such outcomes arise in a competitive equilibrium in which portfolio choices of active managers partially echo those of noise traders and also contain manager-specific noise. Both sources of noise reduce managers’ skill to identify mispriced securities and thereby produce alpha. However, lower skill also means a given amount of active management corrects prices less and thus competes away less alpha. The latter effect can outweigh managers’ poorer portfolio choices, so that investors rationally allocate more to active management when its skill is lower.

Keywords: Active Management, Noise Traders, Skill

JEL Classification: G23, G12, G11

Suggested Citation

Stambaugh, Robert F., Noisy Active Management (June 23, 2017). Available at SSRN: https://ssrn.com/abstract=2990787 or http://dx.doi.org/10.2139/ssrn.2990787

Robert F. Stambaugh (Contact Author)

University of Pennsylvania - The Wharton School ( email )

The Wharton School, Finance Department
University of Pennsylvania
Philadelphia, PA 19104-6367
United States
215-898-5734 (Phone)
215-898-6200 (Fax)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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