Investment Behavior under Uncertainty in Number of Competitors

Abstract

One explanation for why investors crowd into a given strategy, as in the Quant Crisis of 2007, even when they understand its negative implication is that they are often simply not aware of the extent of crowding. In this paper, we build a simple model that formalizes this intuition. To derive excessive crowding, our model relies on two ingredients: (i) an investor’s investment decision imposes a negative externality on other investors, and (ii) investors are uncertain about the amount of competing capital at play. The model then allows us to analyze regulations regarding disclosure of capital committed to a strategy. Interestingly, we nd that it is suboptimal to disclose the amount of capital perfectly to the investors to mitigate the crowding, and that there is a case for strategic blocking of the information. We show that the implementation of the optimal disclosure policy requires a commitment device without which there occurs a policy trap.