Time constrained investors

Some investors do not have a mean-variance preference or goal when making their investment, instead they want to maximize their capital returns over a certain time period. For this type of investors, their attitudes would be very likely to be different from what we consider as rational investors or economic man.

This type of investors are often seen in the real world. Those who work for financial institutions including funds are often this type of investors, since their performances are evaluated every quarter by their committees and sponsors (investors). Then this will explain the change in those investors’ risk preferences when they experience different capital returns. In general, investors are risk seeking when they suffer losses, and risk averse when they experience capital gains. When they make losses, to meet their goals, they have to take more risky and aggressive actions to meet the goals before the evaluation day. However, if they make good progress at the beginning, they want to keep the gains, so they will be more conservative (in other words, more risk averse).

What is the effect of the existence of such investors then? Such investors would behave like noise traders, though they may have very good knowledge about the financial market and the assets they invest in. However, because we know the financial market does not perfectly reflect its fundamentals, the investors with this type will trade based on the market momentum rather than the fundamentals. This will further deviate the financial market from its fundamental value.

Since we know institutional investors including fund managers face performance evaluation pressure from their sponsers, they are like to be this type of investors. Because the institutional investors are influential, the financial market would not be at its fundamental level and would be deviated by the market momentum created by retail investors as well as institutional investors.