Behavioral Finance and the Architecture of the Asset Management Industry

34 Pages Posted: 10 Oct 2019

Date Written: September 29, 2019

Abstract

The standard portfolio approach assumes that investors maximize Expected Utility functions and that the Markowitz Mean-Variance Standard Portfolio Optimization approach can be applied. Behavioral Research, however, indicates that investors’ behavior with respect to risk or uncertainty is not consistent with EU. Notably, decision makers transform probabilities. Most of the academic literature integrating those aspects, however, focuses on so-called financial market anomalies but does not focus on the structural impact those behavioral aspects might have, notably in terms of industrial organization of the asset management industry. This paper analyzes the industrial organization of the asset management industry and argues that the architecture of the asset management industry is inconsistent with the standard EU framework. The origin of the industrial organization of the asset management industry stems from the convexity of the Flow-performance relationship, which is due to Prospect Theory effects. The convexity of the Flow-performance relationship explains the inflation of Mutual Funds and Fund families, a phenomenon inconsistent with the Mutual Fund Separation Theorem.

Keywords: Portfolio Choice, Behavior Under Uncertainty, Behavioral Industrial Organization

JEL Classification: G11, D82, N2

Suggested Citation

Verlaine, Michel, Behavioral Finance and the Architecture of the Asset Management Industry (September 29, 2019). Available at SSRN: https://ssrn.com/abstract=3461372 or http://dx.doi.org/10.2139/ssrn.3461372

Michel Verlaine (Contact Author)

ICN Business School ( email )

13 rue du Marechal Ney
Nancy, 54000
France

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