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Asset Prices When Agents are Marked-to-Market

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  • Gary Gorton
  • Ping He
  • Lixin Huang

Abstract

"Risk management" in securities markets refers to the oversight of portfolio managers and professional traders when they trade on behalf of investors in security markets. Monitoring of their trading performance, profit and loss, and risk-taking behavior, is measured by principals using security market prices. We study the optimality of the practice of marking-to-market and provide conditions under which investing principals should optimally monitor their agent traders using market prices to measure traders' performance. Asset prices, however, can be affected by mark-to-market contracts. We show that such contracts introduce an externality when there are many traders. Traders may rationally herd, trading on irrelevant information. Ironically, this causes asset prices to be less informative than they would be without the mark-to-market feature.

Suggested Citation

  • Gary Gorton & Ping He & Lixin Huang, 2006. "Asset Prices When Agents are Marked-to-Market," NBER Working Papers 12075, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:12075
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    References listed on IDEAS

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    1. Eitan Goldman & Steve L. Slezak, 2003. "Delegated Portfolio Management and Rational Prolonged Mispricing," Journal of Finance, American Finance Association, vol. 58(1), pages 283-311, February.
    2. Brennan, Michael J., 1993. "Agency and Asset Pricing," University of California at Los Angeles, Anderson Graduate School of Management qt53k014sd, Anderson Graduate School of Management, UCLA.
    3. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
    4. Bhattacharya, Sudipto & Pfleiderer, Paul, 1985. "Delegated portfolio management," Journal of Economic Theory, Elsevier, vol. 36(1), pages 1-25, June.
    5. Admati, Anat R & Pfleiderer, Paul, 1997. "Does It All Add Up? Benchmarks and the Compensation of Active Portfolio Managers," The Journal of Business, University of Chicago Press, vol. 70(3), pages 323-350, July.
    6. Dow, James & Gorton, Gary, 1994. " Arbitrage Chains," Journal of Finance, American Finance Association, vol. 49(3), pages 819-849, July.
    7. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
    8. Dow, James & Gorton, Gary, 1997. "Noise Trading, Delegated Portfolio Management, and Economic Welfare," Journal of Political Economy, University of Chicago Press, vol. 105(5), pages 1024-1050, October.
    9. Hui Ou-Yang, 2003. "Optimal Contracts in a Continuous-Time Delegated Portfolio Management Problem," Review of Financial Studies, Society for Financial Studies, vol. 16(1), pages 173-208.
    10. Franklin Allen, 2001. "Do Financial Institutions Matter?," Center for Financial Institutions Working Papers 01-04, Wharton School Center for Financial Institutions, University of Pennsylvania.
    11. Franklin Allen & Gary Gorton, 1993. "Churning Bubbles," Review of Economic Studies, Oxford University Press, vol. 60(4), pages 813-836.
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    Cited by:

    1. Gary B. Gorton, 2008. "The Panic of 2007," NBER Working Papers 14358, National Bureau of Economic Research, Inc.
    2. Gorton, Gary B., 2008. "The panic of 2007," Proceedings - Economic Policy Symposium - Jackson Hole, Federal Reserve Bank of Kansas City, pages 131-262.
    3. Dasgupta, Amil & Prat, Andrea, 2008. "Information aggregation in financial markets with career concerns," Journal of Economic Theory, Elsevier, vol. 143(1), pages 83-113, November.
    4. Stephen Golub & Ayse Kaya & Michael Reay, 2015. "What were they thinking? The Federal Reserve in the run-up to the 2008 financial crisis," Review of International Political Economy, Taylor & Francis Journals, vol. 22(4), pages 657-692, August.
    5. repec:eee:jmacro:v:52:y:2017:i:c:p:287-307 is not listed on IDEAS
    6. Amil Dasgupta & Andrea Prat & Michela Verardo, 2011. "Institutional Trade Persistence and Longā€Term Equity Returns," Journal of Finance, American Finance Association, vol. 66(2), pages 635-653, April.
    7. Micah L. Ingalls & Michael B. Dwyer, 2016. "Missing the forest for the trees? Navigating the trade-offs between mitigation and adaptation under REDD," Climatic Change, Springer, vol. 136(2), pages 353-366, May.

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