Abstract

http://ssrn.com/abstract=1572342
 
 

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Asset Prices and Institutional Investors


Suleyman Basak


London Business School; Centre for Economic Policy Research (CEPR)

Anna Pavlova


London Business School; Centre for Economic Policy Research (CEPR)

August 24, 2012

AFA 2011 Denver Meetings Paper

Abstract:     
Empirical evidence indicates that trades by institutional investors have sizable effects on asset prices, generating phenomena such as index effects, asset-class effects and others. It is difficult to explain such phenomena within standard representative-agent asset pricing models. In this paper, we consider an economy populated by institutional investors alongside standard retail investors. Institutions care about their performance relative to a certain index. Our framework is tractable, admitting exact closed-form expressions, and produces the following analytical results. We find that institutions optimally tilt their portfolios towards stocks that comprise their benchmark index. The resulting price pressure boosts index stocks, while leaving nonindex stocks unaffected. By demanding a higher fraction of risky stocks than retail investors, institutions amplify the index stock volatilities and aggregate stock market volatility, and give rise to countercyclical Sharpe ratios. Trades by institutions induce excess correlations among stocks that belong to their benchmark index, generating an asset-class effect.

Number of Pages in PDF File: 62

Keywords: Asset pricing, indexing, institutions, money management, general equilibrium

JEL Classification: G12, G18, G29

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Date posted: March 17, 2010 ; Last revised: August 27, 2012

Suggested Citation

Basak, Suleyman and Pavlova, Anna, Asset Prices and Institutional Investors (August 24, 2012). AFA 2011 Denver Meetings Paper. Available at SSRN: http://ssrn.com/abstract=1572342 or http://dx.doi.org/10.2139/ssrn.1572342

Contact Information

Suleyman Basak
London Business School ( email )
Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)
HOME PAGE: http://faculty.london.edu/sbasak/
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Anna Pavlova (Contact Author)
London Business School ( email )
Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7000 8218 (Phone)
HOME PAGE: http://faculty.london.edu/apavlova
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
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