The Price of Conformism

As previous agency models have shown, fund managers with career concerns have an incentive to imitate the recent trading strategy of other managers. We embed this rational conformist tendency in a stylized …nancial market with limited arbitrage. Equilibrium prices incorporate a reputational premium or discount, which is a monotonic function of past trade between careerdriven traders and the rest of the market. Our prediction is tested with quarterly data on US institutional holdings from 1983 to 2004. We …nd evidence that stocks that have been persistently bought (sold) by institutions in the past 3 to 5 quarters underperform (overperform) the rest of the market in the next 12 to 30 months. Our results are of similar magnitude to, but distinct from, other known asset pricing anomalies. Our …ndings challenge the mainstream view of the roles played by individuals and institutions in generating asset pricing anomalies.

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