Competition in Portfolio Management: Theory and Experiment

Abstract

W e explore theoretically and experimentally the general equilibrium price and allocation implications of delegated portfolio management when the investor-manager relationship is nonexclusive. Our theory predicts that competition forces managers to promise portfolios that mimic Arrow-Debreu (AD) securities, which investors then combine to fit their preferences. A weak version of the capital asset pricing model (CAPM) obtains, where state prices (relative to state probabilities) implicit in prices of traded securities will be inversely ranked to aggregate wealth across states. Our experiment broadly corroborates the price and choice predictions of the theory. However, price quality deteriorates when only a few managers attract most of the available wealth. Wealth concentration increases because funds flow toward managers who offer portfolios closer to replicating AD securities (as in the theory), but also because funds flow to managers who had better performance in the immediate past (an observation unrelated to the theory).

The impact of ETF index inclusion on stock prices

“…The experimental finance literature (e.g., Bossaerts and Plott, 2004) has consistently found that prices converge towards their equilibrium values, even in difficult scenarios (Asparouhova et al, 2015). Our study extends that work by introducing an ETF index asset.…”

Review of behavioral explanations of how rank-based incentives influence risk taking by investment managers in mutual fund companies

“…It is uncertain to which extent social comparisons and competition play any role in the last cited studies. The results of the other studies except Asparouhova et al (2015) still show that performance-based incentives may increase risk taking with the consequence that assets are mispriced. Increasing the number of prizes in a tournament and penalties are factors that seem to counteract increased risk taking.…”

“…Experimental asset markets (Noussair and Tucker, 2013;Palan, 2013) In noting the increased supply of funds resulting in competition among fund companies to attract investor money, Asparouhova et al (2015) ask what effects this may have on trading and asset prices. In an experiment lasting for six one-week periods, 32 participants (reported to be homogenous in skill and information access) play the role of managers of different funds.…”