A simple model of a money-management market with rational and extrapolative investors

Ran Spiegler ()

European Economic Review, 2020, vol. 127, issue C

Abstract: I analyze a simple model of competition in fees among mutual funds. The funds are vertically differentiated in terms of the expected return they can generate for investors. Following Berk and Green (2004), I assume that a fund’s net return is decreasing in the amount of capital it manages, and that there is an infinite supply of capital by rational investors. Unlike the Berk-Green model, I assume there is also a finite supply of capital by non-rational investors who naively chase recent net returns. Investor behavior and the funds’ fee profile induce a long-run average amount of managed capital for each fund. I analyze Nash equilibrium in the game played by the funds, focusing on the implications of fund skill on fees, capital flows and net performance.

Keywords: Mutual funds; Extrapolative expectations; Smart money; Dumb money; Flow-performance relation; Behavioral industrial organization; Quacks (search for similar items in EconPapers)
Date: 2020
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Persistent link: https://EconPapers.repec.org/RePEc:eee:eecrev:v:127:y:2020:i:c:s0014292120301203

DOI: 10.1016/j.euroecorev.2020.103488

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