Overconfidence in Money Management: Balancing the Benefits and Costs
59 Pages Posted: 3 Apr 2018
Date Written: March 29, 2018
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: Suggested Citation