I propose a parsimonious model that reproduces the negative risk-adjusted performance of actively managed equity mutual funds. In the model, a fund manager can generate state-dependent active returns at a disutility. Negative expected performance and mutual fund investing simultaneously arise in equilibrium because the active return the fund manager generates covaries positively with a component of the pricing kernel that the performance measure omits, consistent with recent empirical evidence. Using data on U.S. funds, I also document new empirical evidence consistent with the model's cross-sectional implications. Disciplines Finance | Finance and Financial ManagementThis journal article is available at ScholarlyCommonsAbstract I propose a parsimonious model that reproduces the negative risk-adjusted performance of actively managed mutual funds and the funds' high abnormal performance realized in bad states of the economy. In the model, a fund manager can generate state-dependent active returns at a disutility. Negative expected performance and mutual fund investing simultaneously arise in equilibrium because the fund's optimal active return covaries positively with a component of the pricing kernel that the performance measure omits. Using data on U.S. funds, I document empirical evidence consistent with the model's cross-sectional implications. JEL classification: G23; G12; G11.

We show that firms intermediating trade have incentives to overinvest in financial expertise. In our model, expertise improves firms’ ability to estimate value when trading a security. Expertise creates asymmetric information, which, under normal circumstances, works to the advantage of the expert as it deters opportunistic bargaining by counterparties. This advantage is neutralized in equilibrium, however, by offsetting investments by competitors. Moreover, when volatility rises the adverse selection created by expertise triggers breakdowns in liquidity, destroying gains to trade and thus the benefits that firms hope to gain through high levels of expertise.

We propose a parsimonious model of bilateral trade under asymmetric information to shed light on the prevalence of intermediation chains that stand between buyers and sellers in many decentralized markets. Our model features a classic problem in economics where an agent uses his market power to inefficiently screen a privately informed counterparty. Paradoxically, involving moderately informed intermediaries also endowed with market power can improve trade efficiency. Long intermediation chains in which each trader's information set is similar to those of his direct counterparties limit traders' incentives to post prices that reduce trade volume and jeopardize gains to trade. (JEL D42, D82, D85, L12, L14)

No abstract

No abstract