Asset Management Contracts and Equilibrium Prices

64 Pages Posted: 8 Sep 2014 Last revised: 5 Oct 2014

Andrea M. Buffa

Boston University

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.

JEL Classification: D53, D86, G12

Suggested Citation

Buffa, Andrea M. and Vayanos, Dimitri and Woolley, Paul, Asset Management Contracts and Equilibrium Prices (September 2014). Boston U. School of Management Research Paper No. 2492529. Available at SSRN: https://ssrn.com/abstract=2492529 or http://dx.doi.org/10.2139/ssrn.2492529

Andrea M. Buffa (Contact Author)

Boston University ( email )

Questrom School of Business
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HOME PAGE: http://sites.google.com/site/andreabuffa/

Dimitri Vayanos

London School of Economics ( email )

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Center for Economic Policy Research (CEPR)

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National Bureau of Economic Research (NBER)

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Cambridge, MA 02138
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Paul Woolley

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

Houghton Street
London, WC2A 2AE
United Kingdom
44-20-7955-7477 (Phone)

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