tailieunhanh - Mutual Funds and Bubbles: The Surprising Role of Contractual Incentives

Next, we analyze the stockholdings implied by the strategies examined here. The evidence shows that predictability-based strategies hold mutual funds with similar size, book-to-market, and momentum characteristics as their no-predictability counterparts. Predictability-based strategies also hold stocks with characteristics similar to those of the holdings of the three previously studied strategies noted earlier. Indeed, the overall attributes of the funds selected by strategies that account for predictable manager skills are quite normal—it is their level of performance that is remarkable | Mutual Funds and Bubbles The Surprising Role of Contractual Incentives Nishant Dass INSEAD France Massimo Massa INSEAD France Rajdeep Patgiri INSEAD France This article studies one of the potential causes of the financial market bubble of the late 1990s the herding behavior of mutual funds. We show that the incentives contained in the mutual funds advisory contracts induce managers to overcome their tendency to herd. We argue that investing in bubble stocks amounts to herding and contracts with high incentives induce managers to diverge from the herd thus reducing their holding of bubble stocks. The differential exposure to bubble stocks significantly impacted the funds performance both in the period prior to March 2000 as well as afterwards. JEL G23 G30 G31 G32 Following the stock market bubble of the late-1990s investment companies have attracted attention due to their potential role in exacerbating the situation by riding the bubble. In particular Brunnermeier and Nagel 2004 find evidence that hedge funds did ride the technology bubble. The intuition for this apparently irrational behavior has been traced back to the limits to arbitrage. If agency issues require fund managers to keep a shortterm perspective then it is optimal for them to invest in overvalued stocks even though they are aware of the bubble. This argument is even more potent if fund managers are evaluated on the basis of relative performance because with relative evaluation underperformance would mean losing future inflows. Even if a fund manager expects the stock market to collapse in the future the manager would not be able to properly arbitrage away the mispricing because short-term underperformance would prevent him from having the assets needed to hold on to the position Shleifer and Vishny 1997 . We thank Franklin Allen Markus Brunnermeier Andrew Ellul Gur Huberman and Maureen O Hara an anonymous referee as well as participants at the RFS-IU Conference on the Causes and Consequence of Recent

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