NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Asset Management Contracts and Equilibrium Prices

Andrea M. Buffa, Dimitri Vayanos, Paul Woolley

NBER Working Paper No. 20480
Issued in September 2014, Revised in February 2019
NBER Program(s):Asset Pricing

We study how the agency relationship between investors and asset managers affects equilibrium prices. We begin with a static contracting model, in which the optimal contract bounds managers’ portfolio risk regardless of their private information. We embed that model into an equilibrium asset-pricing model with noise traders and overlapping generations of investors and managers. Risk limits generate an inverted risk-return relationship: overvalued assets have high volatility because managers buy them during bull markets to meet risk limits. Because overvalued assets have higher share price and volatility, risk limits are more constraining when trading against overvaluation, biasing the aggregate market upward.

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Document Object Identifier (DOI): 10.3386/w20480

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