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  • June 2019
  • Article
  • Journal of Finance

Brokers vs. Retail Investors: Conflicting Interests and Dominated Products

By: Mark Egan
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Abstract

I study how brokers distort household investment decisions. Using a novel convertible bond dataset, I find that consumers often purchase dominated bonds—cheap and expensive versions of otherwise identical bonds coexist in the market. The empirical evidence suggests that broker incentives are responsible for the inferior investments, as brokers earn a 1.12 percentage point higher fee relative to the notional invested for selling the dominated bond on average. I develop and estimate a broker intermediated search model that rationalizes this behavior and quantifies the distortions in these markets. In the model, consumer search is endogenously directed according to the incentives of brokers, and brokers price discriminate based on a consumer's level of sophistication. The model estimates indicate that costly search is a key friction in retail financial markets, but the effects of search costs are compounded when brokers are incentivized to direct the search of consumers towards high fee inferior products.

Keywords

Brokers; Fiduciary Standard; Consumer Finance; Structured Products; Household; Investment; Decisions; Motivation and Incentives; Conflict of Interests

Citation

Egan, Mark. "Brokers vs. Retail Investors: Conflicting Interests and Dominated Products." Journal of Finance 74, no. 3 (June 2019): 1217–1260.
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About The Author

Mark L. Egan

Finance
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  • The Cross Section of Bank Value By: Mark Egan, Stefan Lewellen and Adi Sunderam
  • When Harry Fired Sally: The Double Standard in Punishing Misconduct By: Mark Egan, Gregor Matvos and Amit Seru
  • A Better Way to Assess Managerial Performance By: Mihir Desai, Mark Egan and Scott Mayfield
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