Journal of Political Economy Vol. 130 No. 12 2022

Asset Management Contracts and Equilibrium Prices

Andrea M. Buffa^1,2; Dimitri Vayanos^3,4,5; Paul Woolley⁵

¹ University of Colorado Boulder · ² University of Colorado System · ³ Center for Economic and Policy Research · ⁴ National Bureau of Economic Research · ⁵ London School of Economics and Political Science

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.

DOI

10.1086/720515

Volume

130

Issue

12

Pages

3146-3201

Language

en

Sources

bibtex:phds-export.bib openalex crossref

Cite

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