Asset Price Dynamics When Traders Care About Reputation

What are the equilibrium features of a dynamic …nancial market where traders care about their reputation for ability? We modify a standard sequential trading model to study a …nancial market with career concerns. We show that this market cannot be informationally e¢ cient: there is no equilibrium in which prices converge to the true value, even after an in…nite sequence of trades. This …nding, which stands in sharp contrast with the results for standard …nancial markets, is due to the fact that our traders face an endogenous incentive to behave in a conformist manner. We show that there exist equilibria where career-concerned agents trade in a conformist manner when prices have risen or fallen sharply. We also show that each asset carries an endogenous reputational bene…t or cost, which may lead to systematic mispricing if asset supply is not in…nitely elastic. Keywords: Financial Equilibrium; Career Concerns; Information Cascades; Mispricing. An earlier version of this paper was circulated under the title "Reputation and Asset Prices: A Theory of Information Cascades and Systematic Mispricing". We thank Patrick Bolton, James Dow, Satoshi Kowanishi, Stephen Morris, Hyun Shin, and Dimitri Vayanos for helpful discussions, and seminar participants at the CeFiMS, CEPR-Gerzensee meetings, Heidelberg, Helsinki, IIES-Stockholm, LSE, Munich, NYU, Norwegian School of Economics, Nuremberg, Pompeu Fabra, Warwick Business School, and Yale for comments. Dasgupta thanks the ESPSRC for …nancial support via grant GR/S83975/01. E-mail: [email protected], [email protected]