Delegated Portfolio Management and Rational Prolonged Mispricing

Authors

  • Eitan Goldman,

  • Steve L. Slezak

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    • *Goldman is from the Kenan-Flagler Business School, University of North Carolina at Chapel Hill and Slezak is from the College of Business Administration, University of Cincinnati. We gratefully acknowledge the helpful comments of Douglas Breeden, Jennifer Conrad, Rick Green (the editor), Harold Zhang, the anonymous referee, and the seminar participants at the University of North Carolina at Chapel Hill. We are solely responsible for any errors that might persist.

Abstract

This paper examines how information becomes reflected in prices when investment decisions are delegated to fund managers whose tenure may be shorter than the time it takes for their private information to become public. We consider a sequence of managers, where each subsequent manager inherits the portfolio of their predecessor. We show that the inherited portfolio distorts the subsequent manager's incentive to trade on long-term information. This allows erroneous past information to persist, causing mispricing similar to a bubble. We investigate the magnitude of the mispricing. In addition, we examine endogenous information quality. In some cases, information quality increases when the manager's expected tenure decreases.

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