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Innovation, Delegation, and Asset Price Swings

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  • Yuki SATO

    (University of Lausanne and Swiss Finance Institute)

Abstract

We propose a dynamic asset-market equilibrium model in which (1) an "innovative" asset with as-yet-unknown average payoff is traded, and (2) investors delegate investment to experts. Experts secretly renege on investors' orders and take on leveraged positions in the asset to manipulate investors' beliefs, thereby attracting more orders and fees. Despite agents' full rationality, the combination of experts' moral hazard and investors' learning generates bubble-like price dynamics: gradual upswing, overshoot, and reversal. Consistent with empirical observations, hedge funds "ride" price swings, adjusting holdings counter-cyclically to other financial intermediaries. Capping fees may lower fund leverage, dampen price swings, and improve welfare.

Suggested Citation

  • Yuki SATO, 2015. "Innovation, Delegation, and Asset Price Swings," Swiss Finance Institute Research Paper Series 15-03, Swiss Finance Institute, revised Mar 2015.
    • Handle: RePEc:chf:rpseri:rp1503
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    More about this item

    Keywords

    asset price swings; delegated investment; innovation; learning; moral hazard; signal jamming;
    All these keywords.

    JEL classification:

    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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