Mutual fund flows and window-dressing

Document Type

Article

Publication Date

11-1-2013

Publication Title

Quarterly Review of Economics and Finance

Abstract

We use a sequential game to analyze an agency problem in the mutual fund industry where a representative fund manager considers window-dressing his portfolio holdings for the purpose of attracting fund flows from a representative investor. The manager is motivated to window-dress to improve the investor's perception of managerial skill which may positively affect fund flows in the next period. However, the investor may suspect window-dressing and thus downgrade perceived managerial skill. The model supports a Bayesian Nash equilibrium where the manager window-dresses only when receiving a low return in the first period and the investor withdraws funds only when observing low returns in both periods. Consequently, we show that window-dressing is a rational behavior even when fund outflows may result.

Volume Number

53

Issue Number

4

First Page

440

Comments

© 2013 The Board of Trustees of the University of Illinois.

Last Page

449

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