Overconfidence in Money Management: Balancing the Benefits and Costs

59 Pages Posted: 1 Aug 2018

See all articles by Jung Hoon Lee

Jung Hoon Lee

Vanderbilt University - Finance

Shyam Venkatesan

Ivey Business School, Western University

Date Written: March 28, 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

Suggested Citation

Lee, Jung Hoon and Venkatesan, Shyam Sunder, Overconfidence in Money Management: Balancing the Benefits and Costs (March 28, 2018). Available at SSRN: https://ssrn.com/abstract=3224109 or http://dx.doi.org/10.2139/ssrn.3224109

Jung Hoon Lee (Contact Author)

Vanderbilt University - Finance ( email )

401 21st Avenue South
Nashville, TN 37203
United States
8123603309 (Phone)

Shyam Sunder Venkatesan

Ivey Business School, Western University ( email )

1151 Richmond St
London, Ontario N6A 3K7
Canada

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