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Asset Management Contracts and Equilibrium Prices

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  • Buffa, Andrea
  • Vayanos, Dimitri
  • Woolley, Paul

Abstract

We study the joint determination of fund managers' contracts and equilibrium asset prices. Because of agency frictions, investors make managers' fees more sensitive to performance and benchmark performance against a market index. This makes managers unwilling to deviate from the index and exacerbates price distortions. Because trading against overvaluation exposes managers to greater risk of deviating from the index than trading against undervaluation, agency frictions bias the aggregate market upwards. They can also generate a negative relationship between risk and return because they raise the volatility of overvalued assets. Socially optimal contracts provide steeper performance incentives and cause larger pricing distortions than privately optimal contracts.

Suggested Citation

  • Buffa, Andrea & Vayanos, Dimitri & Woolley, Paul, 2014. "Asset Management Contracts and Equilibrium Prices," CEPR Discussion Papers 10152, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:10152
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    References listed on IDEAS

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    Cited by:

    1. Huang, Shiyang & Lou, Dong & Polk, Christopher, 2016. "The Booms and Busts of Beta Arbitrage," CEPR Discussion Papers 11531, C.E.P.R. Discussion Papers.
    2. Nicolae B. Gârleanu & Lasse H. Pedersen, 2015. "Efficiently Inefficient Markets for Assets and Asset Management," NBER Working Papers 21563, National Bureau of Economic Research, Inc.
    3. Anil K. Kashyap & Natalia Kovrijnykh & Jian Li & Anna Pavlova, 2018. "The Benchmark Inclusion Subsidy," NBER Working Papers 25337, National Bureau of Economic Research, Inc.
    4. Cvitanić, Jakša & Xing, Hao, 2018. "Asset pricing under optimal contracts," Journal of Economic Theory, Elsevier, vol. 173(C), pages 142-180.
    5. Malamud, Semyon, 2016. "A Dynamic Equilibrium Model of ETFs," CEPR Discussion Papers 11469, C.E.P.R. Discussion Papers.
    6. Idan Hodor & Andrea Buffa, 2017. "Institutional Investors, Heterogeneous Benchmarks and the Comovement of Asset Prices," 2017 Meeting Papers 374, Society for Economic Dynamics.
    7. Sato, Yuki, 2016. "Delegated portfolio management, optimal fee contracts, and asset prices," Journal of Economic Theory, Elsevier, vol. 165(C), pages 360-389.
    8. Markus Ibert & Ron Kaniel & Stijn Van Nieuwerburgh & Roine Vestman, 2018. "Are Mutual Fund Managers Paid for Investment Skill?," Review of Financial Studies, Society for Financial Studies, vol. 31(2), pages 715-772.
    9. Matthijs Breugem & Adrian Buss, 2017. "Institutional Investors and Information Acquisition: Implications for Asset Prices and Informational Efficiency," NBER Working Papers 23561, National Bureau of Economic Research, Inc.
    10. Hu, Wei & Zheng, Zhenlong, 2020. "Expectile CAPM," Economic Modelling, Elsevier, vol. 88(C), pages 386-397.
    11. Czech, Robert & Roberts-Sklar, Matt, 2017. "Investor behaviour and reaching for yield: evidence from the sterling corporate bond market," Bank of England working papers 685, Bank of England.
    12. David Lagziel & Ehud Lehrer, 2018. "Transferable Deposits as a Screening Mechanism," Working Papers 1808, Ben-Gurion University of the Negev, Department of Economics.
    13. He, Xue-Zhong & Shi, Lei, 2017. "Index portfolio and welfare analysis under heterogeneous beliefs," Journal of Banking & Finance, Elsevier, vol. 75(C), pages 64-79.
    14. Tobias Adrian & Richard K. Crump & Erik Vogt, 2019. "Nonlinearity and Flight‐to‐Safety in the Risk‐Return Trade‐Off for Stocks and Bonds," Journal of Finance, American Finance Association, vol. 74(4), pages 1931-1973, August.
    15. Rui Albuquerque & Luís Cabral & José Guedes, 2019. "Incentive Pay and Systemic Risk," Review of Financial Studies, Society for Financial Studies, vol. 32(11), pages 4304-4342.
    16. Chabakauri, Georgy & Rytchkov, Oleg, 2014. "Asset pricing with index investing," LSE Research Online Documents on Economics 60739, London School of Economics and Political Science, LSE Library.
    17. Andrei, Daniel & Cujean, Julien & Wilson, Mungo, 2018. "The Lost Capital Asset Pricing Model," CEPR Discussion Papers 12607, C.E.P.R. Discussion Papers.
    18. Garleanu, Nicolae Bogdan & Pedersen, Lasse Heje, 2018. "Efficiently Inefficient Markets for Assets and Asset Management," CEPR Discussion Papers 12664, C.E.P.R. Discussion Papers.
    19. Matthijs Breugem & Adrian Buss, 2017. "Institutional Investors and Information Acquisition: Implications for Asset Prices and Informational Efficiency," Carlo Alberto Notebooks 524, Collegio Carlo Alberto.
    20. Boguth, Oliver & Simutin, Mikhail, 2018. "Leverage constraints and asset prices: Insights from mutual fund risk taking," Journal of Financial Economics, Elsevier, vol. 127(2), pages 325-341.
    21. Alex R. Horenstein, 2017. "Betting Against Alpha," Working Papers 2017-13, University of Miami, Department of Economics.

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    More about this item

    Keywords

    asset pricing; delegated portfolio management; market anomalies; optimal contracts;
    All these keywords.

    JEL classification:

    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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