The Louis Vuitton effect: a case study on perceived value

 Visit LinkedIn ProfileAntti Parviainen, 16 October 2012

The Louis Vuitton effect: a case study on perceived value

The "Crazy Days" at Stockmann (sales event in a department store called Stockmann) are approaching. For just under a week during the Stockmann 'Crazy Days' you get quality goods, cheaper than normal. People rush around determined, zigzagging around the shops with their yellow bags dangling. The price elasticity of products and services always tends to be negative. In other words: falling prices raise demand.

In economics, however, we also find situations where demand increases, when the price goes up. This is a rare phenomenon, i.e. the so-called Giffen or Veblen goods. Such a phenomenon may occur for example in some luxury goods for which the value is difficult to compare and a part of its value is based on its price. For example, part of the value of a Louis Vuitton bag is based on its high price. If the price would decrease, many wealthy people would maybe reject the product. Not because of the decrease in price, but the decrease in value.

Can this kind of situation arise in investment products? In some investment options the product's perceived value may be linked to high management fees. The structurer or portfolio manager in this instance is thought to be superior to others. How could he otherwise be able to charge such a high fee?

Empirical studies strongly favour the view that high fees do not improve the returns on the investments. Of particular harm are fees linked to returns. These can easily lead to unreasonably high fees only because of a favourable market trend and not because of a skilled portfolio manager. Additionally, this fee structure will easily lead to a situation which encourages portfolio managers to take on an exceptionally high degree of risk or to structure the investment product with an asymmetric risk profile.

Some say it's for crazy people to go to the crazy days. Personally I think it's crazy to pay more for any product just because the price is higher. I was thinking of going to the 'Crazy Days': I might be able to get investment products cheaper than usual!

Antti is Head of Structured Products, FIN at Nordea.

This post is translated from Finnish. View the original post here.

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