Reputation Concerns and Slow-Moving Capital

This paper analyzes fund managers’ reputation concerns in a dynamic equilibrium model. It offers a unified explanation for a number of seemingly unrelated phenomena. The model shows why many popular hedge fund trading strategies have negatively skewed return distributions. It also offers an explanation for the documented phenomenon that capital sometimes appears to be slow moving, leaving attractive investment opportunities unexploited, yet other times appears capricious, flying quickly from one strategy to another and leading to large capital relocation and price fluctuations without any news about the fundamentals. More broadly, the analysis demonstrates the limitation of the role of market discipline. Fund managers may distort their investment strategies precisely because of certain market discipline. JEL Classification Numbers: G11, G23.