Abstract
We propose a simple, equilibrium model where investors hire fund managers to invest their capital either in a risky bond or in a riskless asset. The risky bonds are issued by a large number of borrowers who run risky investment and can decide to default expost. There is only a small fraction of talanted fund managers who have information on the fundamentals of the risky project. This generates career concerns that distort the investment decision of uninformed fund managers. When the probability of default is su¢ ciently high, they prefer to invest in safe bonds even at a lower expected return to reduce the probability of being …red. This is what we de…ne premium. As the economic and …nancial conditions change, the reputational premium can switch sign. This generates an overreaction of the market leading to excess volatility of spreads, capital ‡ows and economic activity.
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