“Self-Enhancing Transmission Bias and Active Investing” by Bing Han
University of Texas at Austin
University of California at Irvine
Individual investors often invest actively and lose thereby. Social interaction seems to exacerbate this tendency. In the model here, senders' propensity to discuss their strategies' returns, and receivers' propensity to be converted, are increasing in sender return. The rate of conversion of investors to active investing is convex in sender return. Unconditionally, active strategies (high variance, skewness, and personal involvement) dominate the population unless the mean return penalty to active investing is too large. Thus, the model can explain overvaluation of `active' asset characteristics even when investors have no inherent preference over them.