A Delegated Agent Asset-Pricing Model
UCLA Anderson School of Management, Finance Working Papers Series 3-04
27 Pages Posted: 18 Jul 2009
Date Written: February 2004
Asset pricing theory has traditionally made predictions about risk and return, but has been silent on the actual process of investment. Many if not most investors delegate major investment decisions to professionals, to investment managers and financial advisors. This suggests that the instructions given by investors to their delegated agents and the compensation of those agents might be important determinants of capital market equilibrium. In the extreme when all investment decisions are delegated, the preferences and beliefs of individuals would be completely superseded by the objective functions of agent/managers. Agency theory holds that such objective functions cannot be isomorphic to principals' preferences and beliefs, which suggests that asset pricing could differ fundamentally from that predicted by existing theory. A simple example of the difference is provided in this paper based active asset management relative to a benchmark index, a common objective function in practice but with no grounding in traditional theory. With the growing preponderance of delegated investing, future asset pricing theory will not only have to describe risk and return but, to be complete, must also be able to explain the observed objective functions used by professional managers.
Keywords: asset pricing
JEL Classification: G12
Suggested Citation: Suggested Citation