Overconfidence in Money Management: Balancing the Benefits and Costs

59 Pages Posted: 3 Apr 2018  

Jung Hoon Lee

Tulane University - A.B. Freeman School of Business

Shyam Venkatesan

Ivey Business School, Western University

Date Written: March 29, 2018

Abstract

Individuals are overconfident, especially those in positions to influence outcomes. The impact of hiring an overconfident portfolio manager is studied here within the standard principal-agent framework. When compensation is endogenously determined, we find that investors can benefit from managerial overconfidence. Overconfidence induces a higher level of effort until the effects of restrictions on portfolio formation take over. Further, by increasing the incentive fee and sharing more risk the investor can curb excessive risk taking. However, excessive overconfidence is detrimental to the investor. We empirically test and confirm the effects of portfolio constraints and incentive fee on manager’s self-attribution bias.

Keywords: Mutual fund, overconfidence, management contracts

JEL Classification: G23, M52

Suggested Citation

Lee, Jung Hoon and Venkatesan, Shyam, Overconfidence in Money Management: Balancing the Benefits and Costs (March 29, 2018). Available at SSRN: https://ssrn.com/abstract=3152417 or http://dx.doi.org/10.2139/ssrn.3152417

Jung Hoon Lee

Tulane University - A.B. Freeman School of Business ( email )

7 McAlister Drive
New Orleans, LA 70118
United States

Shyam Sunder Venkatesan (Contact Author)

Ivey Business School, Western University ( email )

1151 Richmond St
London, Ontario N6A 3K7
Canada

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