Asset Management Contracts and Equilibrium Prices
94 Pages Posted: 8 Sep 2014 Last revised: 30 Jun 2022
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Asset Management Contracts and Equilibrium Prices
Asset Management Contracts and Equilibrium Prices
Asset Management Contracts and Equilibrium Prices
Date Written: March 29, 2022
Abstract
We model asset management as a continuum between active and passive: managers can deviate from benchmark indices to exploit noise-trader induced distortions, but agency frictions constrain these deviations. Because constraints force managers to buy assets that they underweight when these assets appreciate, overvalued assets have high volatility, and the risk-return relationship becomes inverted. Distortions are more severe for overvalued assets than for undervalued ones because trading against the former entails more risk and tighter constraints. We provide empirical evidence supporting our model’s main mechanisms. Using the data, we infer the constraints’ tightness and compute a measure of effective arbitrage capital.
JEL Classification: D53, D86, D82, G11, G12
Suggested Citation: Suggested Citation