Endogenous Dynamic Concentration of the Active Fund Management Industry

We introduce continuous-time rational models of concentration in the active fund management industry (AFMI), where managers with heterogeneous dynamic unobservable abilities compete for investments of risk-neutral or risk-averse investors. Dynamics of managers’ inferred abilities determine equilibrium dynamics of returns, fund flows, fund sizes, and thus concentration, measured by the Herfindahl-Hirschman Index (HHI). Positive performance shocks of managers whose inferred abilities are sufficiently large (small), relative to those of other managers, exert positive (negative) impacts on HHI, but higher performance variations of these managers mitigate these impacts. Our empirical results support our theory