Brokers vs . Retail Investors : Con icting Interests and Dominated Products

PRELIMINARY AND INCOMPLETE, PLEASE DO NOT CITE WITHOUT PERMISSION. Using a new dataset covering reverse convertible bonds, this paper nds evidence of retail consumers frequently buying unambiguously dominated nancial products. It is common practice for a bank to simultaneously issue identical reverse convertible bonds at the same price with di erent interest rates/coupons such that the payout of one bond unambiguously dominates that of the other. The empirical evidence reveals that, when available, consumers purchase 16% more of the dominated product. Such behavior is rationalized by nancial product distribution. On average, brokers earned a 1.12% point higher commission for selling the dominated product. I develop a search model that incorporates the con ict of interest between brokers and consumers that rationalizes product issuance and the behavior of consumers. Lastly, I structurally estimate the model to analyze the impact of the proposed broker regulations of the Dodd-Frank Act. I nd that holding brokers to a duciary standard over the period 2008-2012 would have increased investor returns by as much as 81 basis points per annum. ∗Mark Egan: University of Chicago Department of Economics, 1126 East 59th Street Chicago, IL 60637, [email protected]. I am grateful for the comments received from Ali Hortaçsu, Amit Seru, Gregor Matvos, Tobias Moskowitz, Jesse Shapiro, Eric Budish, Juhani Linnainmaa, Neale Mahoney, Monika Piazzesi and Chad Syverson as well as seminar participants at the North American Econometric Society Meetings and at the University of Chicago Booth School of Business Finance Seminar.