Working Paper: NBER ID: w22697
Authors: Nicolae Grleanu; Stavros Panageas; Jianfeng Yu
Abstract: We propose a tractable model of an informationally inefficient market featuring non-revealing prices, no noise traders, and general assumptions on preferences and payoff distributions. We show the equivalence between our model and a substantially simpler model whereby investors face distortionary investment taxes depending both on their identity and the asset class. This equivalence allows us to account for such phenomena as under-diversification. We further employ the model to assess approaches to performance evaluation, and find that it provides a theoretical basis for some intuitive practices adopted by finance professionals, such as style analysis.
Keywords: informational asymmetries; performance evaluation; Jensen's alpha; underdiversification; financial markets
JEL Codes: G11; G12; G14
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Informational asymmetries (D82) | underdiversification among investors (G11) |
| Failure rate of signals (L96) | investment decisions (G11) |
| Informational asymmetries (D82) | concentration of portfolios in locations with perceived informational advantage (R32) |
| Performance evaluation criteria must be tailored (C52) | valid performance measure should assign zero alpha to passive strategies (G11) |
| Jensen's alpha (G19) | may fail to accurately identify investors' informational advantages (G14) |
| Informed investors (G11) | exhibit negative alpha even when possessing superior selection skills (G41) |