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Asset Prices When Agents are Marked-to-Market

  • Gary Gorton
  • Ping He
  • Lixin Huang

"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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12075.

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Date of creation: Mar 2006
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Handle: RePEc:nbr:nberwo:12075
Note: AP CF
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  1. Bengt Holmstrom, 1982. "Moral Hazard in Teams," Bell Journal of Economics, The RAND Corporation, vol. 13(2), pages 324-340, Autumn.
  2. James Dow & Gary Gorton, . "Arbitrage Chains," Rodney L. White Center for Financial Research Working Papers 6-93, Wharton School Rodney L. White Center for Financial Research.
  3. 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.
  4. 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.
  5. 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.
  6. James Dow & Gary Gorton, 1994. "Noise Trading, Delegated Portfolio Management, and Economic Welfare," NBER Working Papers 4858, National Bureau of Economic Research, Inc.
  7. Bhattacharya, Sudipto & Pfleiderer, Paul, 1985. "Delegated portfolio management," Journal of Economic Theory, Elsevier, vol. 36(1), pages 1-25, June.
  8. 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 323-50, July.
  9. Franklin Allen, 2001. "Do Financial Institutions Matter?," Center for Financial Institutions Working Papers 01-04, Wharton School Center for Financial Institutions, University of Pennsylvania.
  10. Allen, Franklin & Gorton, Gary, 1993. "Churning Bubbles," Review of Economic Studies, Wiley Blackwell, vol. 60(4), pages 813-36, October.
  11. 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, 02.
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