Asset Management Contracts and Equilibrium Prices

67 Pages Posted: 25 Sep 2014

See all articles by Andrea M Buffa

Andrea M Buffa

University of Colorado at Boulder - Leeds School of Business

Dimitri Vayanos

London School of Economics; Center for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Paul Woolley

London School of Economics & Political Science (LSE)

Multiple version iconThere are 3 versions of this paper

Date Written: September 2014

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.

Keywords: asset pricing, delegated portfolio management, market anomalies, optimal contracts

JEL Classification: D86, G12, G14, G18, G23

Suggested Citation

Buffa, Andrea M and Vayanos, Dimitri and Woolley, Paul, Asset Management Contracts and Equilibrium Prices (September 2014). CEPR Discussion Paper No. DP10152, Available at SSRN: https://ssrn.com/abstract=2501635

Andrea M Buffa (Contact Author)

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

Dimitri Vayanos

London School of Economics ( email )

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Houghton Street
London WC2A 2AE
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Center for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Paul Woolley

London School of Economics & Political Science (LSE) ( email )

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United Kingdom
44-20-7955-7477 (Phone)

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