s p 500 cash stock price volatilities s p 500 stock return volatilities are compared to the volatilities of a matched set of stocks after controlling for cross sectional differences in firm attributes known to affect volatility no significant difference in volatility is observed between 1975 and 1983before the start of trade in index futures and index options since then s p 500 stocks have been relatively more volatile the difference is statistically but not economically significant the relative increase occurs primarily in daily returns and only to a lesser extent in longer interval returns other factors besides the start of derivative trade could be responsible for the small increase in volatility stock price volatility has received much attention in the popular press over the last few years especially since the october 19 1987 stock market crash the rise in volatility has alarmed investors regulators and the public in general some suggest that the start of trade in stock index futures and index options increased speculative activity that in turn destabilized cash markets causing higher volatility large trading activity in the derivative contracts makes the suggestion plausible volume in index futures and index options increased dramatically since their introductions in 1982 and 1983 by 1987 the average daily dollar volume in the s p 500 futures contracts alone exceeded the dollar volume of cash s p 500 trade by a factor of about two while the dollar value of the daily net change in total open interest is about 8 of s p 500 stock dollar volume speculative trade in futures and options frequently is accused of destabilizing underlying cash markets the charge has been made for more than a century in the agricultural precious metal and currency markets recent evidence by french and roll 1986 showing stock variance to be strongly related to trading session hours heightens these concerns unfortunately theoretical analyses of whether speculative trade destabilizes cash markets lead to conflicting conclusions depending on what assumptions are made 1 school of business administration university of southern california and office of economic analysis u s securities and exchange commission i wish to thank mary denny mcsweeny and steve hornstein for their valuable research assistance and the referee and editor for their many suggestions and insights the opinions expressed in this paper do not necessarily reflect those of the u s securities and exchange commission or those of the author s colleagues on its staff an increase in well informed speculative trade has two opposite effects on measured volatility it decreases volatility due to order flow imbalances caused by uninformed traders because informed traders provide liquidity in such events and it increases volatility due to new fundamental information since the information which is assumed to be generated at discrete time intervals is impounded into

rewarding risk taking or skill the case of private equity fund managers abstract we examine whether typical private equity fund compensation contracts reward excessive risk taking rather than managerial skill our analysis is based on a novel model of investment value cash flows and fee dynamics of private equity funds given the embedded option like fee components our results demonstrate that fund managers indeed have an incentive for excessive risk taking when only fee income from the current fund is considered however when managers also consider potential compensation from follow on funds their risk taking incentives depend on their individual skill levels and skilled managers will have an incentive to reduce fund risk we also show that managers must generate substantial abnormal returns in order to compensate investors for the given fee components

delegated portfolio management abstract a problem of screening agents with privately known forecasting abilities and reservation utilities and then eliciting truthful information from these agents once they are employed is considered for the case of risk averse agents and large principals an approximately optimal solution is constructively characterized under the assumption that payoffs are normally distributed a significant extension of the definnetti savage probability elicitation result is developed under this extension knowledge of agent preferences is not required when the underlying conditional distributions are symmetric and this fact is exploited to solve the screening problem in a mean variance formulation

asset prices and institutional investors empirical evidence indicates that trades by institutional investors have sizable effects on asset prices generating phenomena such as index effects asset class effects and others it is difficult to explain such phenomena within standard representative agent asset pricing models in this paper we consider an economy populated by institutional investors alongside standard retail investors institutions care about their performance relative to a certain index our framework is tractable admitting exact closed form expressions and produces the following analytical results we find that institutions optimally tilt their portfolios towards stocks that comprise their benchmark index the resulting price pressure boosts index stocks while leaving nonindex stocks unaffected by demanding a higher fraction of risky stocks than retail investors institutions amplify the index stock volatilities and aggregate stock market volatility and give rise to countercyclical sharpe ratios trades by institutions induce excess correlations among stocks that belong to their benchmark index generating an asset class effect institutions finance their additional purchases of index stocks by taking on leverage a policy prescription that calls for a reduction in leverage while reducing the riskiness of institutional portfolios would also reduce the ability of institutions to tilt their portfolios towards index stocks depressing the index level

optimal asset allocation and risk shifting in money management this article investigates a fund manager s risk taking incentives induced by an increasing and convex relationship of fund flows to relative performance in a dynamic portfolio choice framework we show that the ensuing convexities in the manager s objective give rise to a finite risk shifting range over which she gambles to finish ahead of her benchmark such gambling entails either an increase or a decrease in the volatility of the manager s portfolio depending on her risk tolerance in the latter case the manager reduces her holdings of the risky asset despite its positive risk premium our empirical analysis lends support to the novel predictions of the model

the impact of different incentive schemes on asset prices abstract how people are incentivized is one of the main drivers of how they behave in laboratory asset markets we evaluate the impact of four trader incentive bonus bonus with cap linear and penalty on asset prices and trader behavior we find that i an asset with identical expected dividend shows price levels which differ by more than 100 percent depending on the incentive scheme subjects face in particular prices of markets populated by subjects with bonus incentives show the highest prices whereas those with penalty like incentivized subjects exhibit the lowest ii however subjects act approximately rational as different incentives generate different optimal price levels iii in markets where different subjects have different incentive schemes we find that those with bonus incentives exhibit a riskier investment behavior and prefer the riskier asset whereas subjects with penalty incentives invest conservatively and mainly hold cash since we find no difference in risk attitude of subjects prior to the experiment differences in investment behavior are induced by the applied incentives our results highlight that incentives on financial markets have a huge impact on asset prices and investment behavior

moral hazard and the portfolio management problem this paper investigates the significance of nonlinear contracts on the incentive for portfolio managers to collect information in addition the manager must be motivated to disclose this information truthfully we analyze three contracting regimes 1 first best where effort is observable 2 linear with unobservable effort and 3 the optimal contract within the bhattacharya pfleiderer quadratic class we find that the linear contract leads to a serious lack of effort expenditure by the manager this underinvestment problem can be successfully overcome through the use of quadratic contracts these contracts are shown to be asymptotically optimal for very risk tolerant principals

on the size of the active management industry we argue that active management s popularity is not puzzling despite the industry s poor track record our explanation features decreasing returns to scale as the industry s size increases every manager s ability to outperform passive benchmarks declines the poor track record occurred before the growth of indexing modestly reduced the share of active management to its current size at this size better performance is expected by investors who believe in decreasing returns to scale such beliefs persist because persistence in industry size causes learning about returns to scale to be slow the industry should shrink only moderately if its underperformance continues

costly search and mutual fund flows this paper studies the flows of funds into and out of equity mutual funds consumers base their fund purchase decisions on prior performance information but do so asymmetrically investing disproportionately more in funds that performed very well the prior period search costs seem to be an important determinant of fund flows high performance appears to be most salient for funds that exert higher marketing effort as measured by higher fees flows are directly related to the size of the fund s complex as well as the current media attention received by the fund which lower consumers search costs

strategic interactions and portfolio choice in money management theory and evidence the author study portfolio choice of strategic fund managers in the presence of a peer based under performance penalty while the penalty generates herding behavior correlated trading among managers is exacerbated when a strategic setting is considered the equilibrium portfolios are driven by the least restricted manager who may vary according to the realization of returns the author compare model predictions to evidence from the colombian pension fund management industry where six asset managers are incharge of portfolio allocation for the mandatory contributions of the working population these managers are subject to a peer based under performance penalty known as the minimum return guarantee mrg the author study trading behavior by managers before and after a change in the strictness of the mrg in june 2007 the evidence suggests that a tighter mrg results in more trading in the direction of peers a behavior that is more pronounced for under performing managers is how that these findings areconsistent with the qualitative and quantitative predictions of the theoretical model

security design with status concerns abstract this paper provides a status based explanation for convertible securities an entrepreneur with status concerns inducing risk taking decides how to finance the firm and how to dynamically manage it solving analytically for the optimal security we find that it is substantially similar to a convertible security our model can explain why convertible securities are mainly issued by start ups and small firms as we show that their salient characteristics higher volatility and dynamic flexibility accentuate incentives to issue convertible securities we also provide analytical results relevant to quantifying how status concerns affect credit risk an established factor behind security choice

fee speech signaling risk sharing and the impact of fee structures on investor welfare the fee structure used to compensate investment advisers is central to the study of fund design and affects investor welfare in at least three ways i by influencing the portfolioselection incentives of the adviser ii by affecting risk sharing between adviser and investor and iii through its use as a signal of quality by superior investment advisers in this paper we describe a model in which all of these features are present and use it to compare two popular and contrasting forms of fee contracts the fulcrum and the incentive types from the standpoint of investor welfare while the former has some undeniably attractive features that have in particular been used by regulators to justify its mandatory use in a mutual fund context we find surprisingly that it is the latter that is often more attractive from the standpoint of investor welfare our model is a flexible one our conclusions are shown to be robust to many extensions of interest the results are also extended to consider unrestricted fee structures and competitive markets for fund managers

public debt under limited private credit there is a conventional wisdom in economics that public debt can serve as a substitute for private credit if private borrowing is limited the purpose of this paper is to show that while a government could in principle use such a policy to fully relax borrowing limits this is not generally optimal in our economy agents invest in a short term asset a long term asset and government bonds agents are subject to idiosyncratic liquidity shocks prior to the maturity of the long term asset we show that a high public debt policy fully relaxes private borrowing limits and is suboptimal this is because agents expecting such a policy respond by investing less than is socially optimal in the short asset which can protect them in the event of a liquidity shock the optimal policy is more constrained and it induces a wedge between the technological rate of return on the long asset and the rate of return on bonds in such a regime agents subject to liquidity shocks are also borrowing constrained and this expectation of being borrowing constrained induces them to invest the optimal level in the short asset jel h63 e62 g20

riding the bubble with convex incentives we oer a simple portfolio choice based rationale for the documented failure of institutional investors to trade against mispriced securities in a dynamic model where informed and risk averse money managers face convex i e option like incentives we show that the standard mean variance component and hedging demand that make up their portfolio often imply opposite stances against mispricing the rst component represents managers bets against overpriced securities by contrast managers hedge against the risk of forfeiting an end of period bonus payment can over weigh overpriced securities even with respect to the market portfolio this bubble riding component is more likely to drive the managers portfolio as overpricing increases although we do not model the informed managers price impact our analysis suggests that the incentives of sophisticated investors might drive them to exacerbate security mispricing

delegated portfolio management a survey of the theoretical literature abstract this paper provides a selective review of the theoretical literature on delegated portfolio management as a principal agent relationship the main focus of the paper is to review the analytical issues raised by the peculiar nature of the delegated portfolio management relationship within the broader class of principal agent models in particular the paper discusses the performance of linear versus nonlinear compensation contracts in a single period setting the possible effects of limited liability of portfolio managers the role of reputational concerns in a multiperiod framework and the incentives to noise trading in addition the paper deals with some general equilibrium dimensions and asset pricing implications of delegated portfolio management the paper also suggests some directions for future research

asset pricing with heterogeneous beliefs and relative performance we propose an equilibrium asset pricing model in which agents with heterogeneous beliefs care about relative performance we find that the concern with relative performance leads agents to trade more similarly a development that has two effects first similar trading directly decreases volatility second similar trading decreases the impact of dominant agents the second effect dominates the first when agents expect large differences between their final performances and vice versa when agents expect small differences between their final performances compared with the case in which agents are unconcerned about relative performance the stock return volatility is higher when the second effect dominates and lower when the first effect dominates this paper also demonstrates that the concern about relative performance influences investors holdings stock prices and risk premia

of tournaments and temptations an analysis of managerial incentives in the mutual fund industry we test the hypothesis that when their compensation is linked to relative performance managers of investment portfolios likely to end up as losers will manipulate fund risk differently than those managing portfolios likely to be winners an empirical investigation of the performance of 334 growth oriented mutual funds during 1976 to 1991 demonstrates that mid year losers tend to increase fund volatility in the latter part of an annual assessment period to a greater extent than mid year winners furthermore we show that this effect became stronger as industry growth and investor awareness of fund performance increased over time

the effects of financial education in the workplace evidence from a survey of households abstract we use a novel household survey to investigate the effects of employer based financial education on personal saving we explore cross sectional relations between the availability of employer based financial education and various measures of asset accumulation and we interpret these patterns in light of various potentially confounding factors our findings favor the hypothesis that employer based financial education stimulates saving both in general and for retirement

an anatomy of the s p game the effects of changing the rules this study analyzes the effects of changes in s p 500 index composition from january 1986 through june 1994 a period during which standard and poor s began its practice of preannouncing changes five days beforehand the new announcement practice has given rise to the s p game and has altered the way stock prices react we find that prices increase abnormally from the close on the announcement day to the close on the effective day the overall increase is greater than under the old announcement policy although part of the increase reverses after the stock is included in the index the s p game is based upon the perceived price reaction of a stock to news that it will be added to the s p 500 the game involves buying the shares of the stock ahead of s p 500 funds and then selling after index fund demand is satisfied the opportunity to play the s p game arose in october 1989 when standard and poor s p began its practice of preannouncing changes to the s p 500 before that time s p announced the change in composition after the close of trading with the change becoming effective by the following morning s open with no lead time index funds bought the shares of the newly included stock on the day following the announcement the buying pressure caused prices to rise for additions during the period 1976 through 1983 for example shleifer 1986 found an abnormal price increase of 2 79 percent on the day following the announcement using roughly the same sample period harris and gurel 1986 reported a 3 13 percent average increase

the dynamics of portfolio management contracts we consider the multiperiod relationship between a client and a portfolio manager and the resulting problem of motivating a manager of unknown ability to acquire valuable information we explore the contractual forms and the optimal retention policy of the client and find that the optimal initial set of contracts features a smaller performance based fee component paid to the manager than in a first best contract and the contract choice elicits only partial information about the manager as a result ex post performance measurement is critical to future recontracting in general managers are retained only if the returns on their portfolio exceed the benchmark by an appropriate amount article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

management compensation and market timing under portfolio constraints abstract this paper shows that portfolio constraints have important implications for management compensation and performance evaluation in particular in the presence of portfolio constraints allowing for benchmarking can be beneficial benchmark design arises as an alternative effort inducement mechanism vis a vis relaxing portfolio constraints numerically we solve jointly for the manager s linear incentive fee and the optimal benchmark the size of the incentive fee and the risk adjustment in the benchmark composition are increasing in the investor s risk tolerance and the manager s ability to acquire and process private information

difference in interim performance and risk taking with short sale constraints abstract absent much theory empirical works often rely on the following informal reasoning when looking for evidence of a mutual fund tournament if there is a tournament interim winners have incentives to decrease their portfolio volatility as they attempt to protect their lead while interim losers are expected to increase their volatility so as to catch up with winners we consider a rational model of a mutual fund tournament in the presence of short sale constraints and find the opposite interim winners choose more volatile portfolios in equilibrium than interim losers several empirical works present evidence consistent with our model however based on the above informal argument they appear to conclude against the tournament behavior we argue that this conclusion is unwarranted we also demonstrate that tournament incentives lead to differences in interim performance for otherwise identical managers and that mid year trading volume is inversely related to mid year stock return

new evidence on stock price effects associated with changes in the s p 500 index since october 1989 standard and poor s has when possible announced changes in the composition of the s p 500 index one week in advance because index funds hold s p 500 stocks to minimize tracking error index composition changes since this date provide an opportunity to examine the market reaction to an anticipated change in the demand for a stock using post october 1989 data the authors document significantly positive negative postannouncement abnormal returns that are only partially reversed following additions deletions these results indicate the existence of temporary price pressing and downward sloping long run demand curves for stocks and represent a violation of market efficiency copyright 1997 by university of chicago press

optimal consumption and portfolio policies when asset prices follow a diffusion process abstract we consider a consumption portfolio problem in continuous time under uncertainty a martingale technique is employed to characterize optimal consumption portfolio policies when there exist nonnegativity constraints on consumption and on final wealth we also provide a way to compute and verify optimal policies our verification theorem for optimal policies involves a linear partial differential equation unlike the nonlinear partial differential equation of dynamic programming the relationship between our approach and dynamic programming is discussed we demonstrate our technique by explicitly computing optimal policies in a series of examples in particular we solve the optimal consumption portfolio problem for hyperbolic absolute risk aversion utility functions when the asset prices follow a geometric brownian motion the optimal policies in this case are no longer linear when nonnegativity constraints on consumption and on final wealth are included by these examples one can see that our approach is much easier than the dynamic programming approach

employee financial literacy and retirement plan behavior a case study this article uses administrative data on all active employees of the federal reserve fr system to examine participation in and contributions to the thrift saving plan the system s defined contribution dc plan we link to administrative records a unique employee survey of economic demographic factors including a set of financial literacy questions not surprisingly fr employees are substantially more financially literate than the population at large most importantly financially savvy employees are also most likely to participate in their dc plan sophisticated workers contribute three percentage points more of their earnings to the dc plan than do the less knowledgeable and they hold more equity in their pension accounts we examine changes in employee plan behavior 1 year after employees completed a learning module about retirement planning and we compare it to baseline patterns we find that those employees who completed the learning module were more likely to start contributing and less likely to have stopped contributing to the dc plan postsurvey in sum employer provided learning programs are shown to significantly impact employee retirement saving decisions and consistent with a lot of other research higher levels of financial literacy are found to have a beneficial impact on retirement saving patterns jel j3 h7

managerial responses to incentives control of firm risk derivative pricing implications and outside wealth management a b s t r a c t we model a firm s value process controlled by a manager maximizing expected utility from restricted shares and employee stock options the manager also controls allocation of his outside wealth which allows partially hedging of his exposure to firm risk managerial control increases the expected time to exercise for his employee stock options it also reduces the gap between his certainty equivalent and the firm s fair value for his compensation but that gap remains substantial managerial control also causes traded options to exhibit an implied volatility smile with costly control the same basic patterns remain but the manager s risk taking is dampened

optimal risk sharing with effort and project choice we consider first best risk sharing problems in which the agent can control both the drift effort choice and the volatility of the underlying process project selection in a model of delegated portfolio management it is optimal to compensate the manager with an option type payoff where the functional form of the option is obtained as a solution to an ordinary differential equation in the general case the optimal contract is a fixed point of a functional that connects the agent s and the principal s maximization problems we apply martingale duality methods familiar from optimal consumption investment problems

adverse risk incentives and the design of performance bases contracts this paper uses option pricing theory to value and analyze many performance based fee contracts that are currently in use a potential problem with some of these contracts is that they may induce portfolio managers to adversely alter the risk of the portfolios they manage the paper is prescriptive in that it presents conditions for contract parameters that provide proper risk incentives for classes of investment strategies for buy and hold and rebalancing strategies adverse risk incentives are avoided when the penalties for poor performance outweigh the rewards for good performance

effectiveness of employer provided financial information hiring to retiring in order to maximize lifetime utility workers must make choices throughout their careers to plan and save for retirement with the aging of the baby boomers and increasing life expectancies it is more important than ever for individuals to ensure they have adequate savings and resources for retirement to make optimal choices individuals need sufficient knowledge of how both national and employer provided retirement plans work and what benefits they should expect further they must have adequate financial literacy to navigate complex financial instruments and to understand the importance of various plan characteristics traditional models of life cycle earnings and consumption are based on the assumption that workers are aware of investment options understand the benefits they will receive from various retirement plans and have the ability to assess the impact of their saving decisions

equilibrium prices in the presence of delegated portfolio management abstract this paper analyzes the asset pricing implications of commonly used portfolio management contracts linking the compensation of fund managers to the excess return of the managed portfolio over a benchmark portfolio the contract parameters the extent of delegation and equilibrium prices are all determined endogenously within the model we consider symmetric fulcrum performance fees distort the allocation of managed portfolios in a way that induces a significant and unambiguous positive effect on the prices of the assets included in the benchmark and a negative effect on the sharpe ratios asymmetric performance fees have more complex effects on equilibrium prices and sharpe ratios with the signs of these effects fluctuating stochastically over time in response to variations in the funds excess performance

institutional ownership and changes in the s p 500 several recent articles have provided new evidence for the existence of price pressures by examining the price and volume effects associated with changes in the s p 500 the present study extends this work by examining actual changes in institutional holdings following both additions to and deletions from the s p 500 the results show that changes in institutional holdings in response to additions or deletions from the s p 500 are positively correlated in addition to providing further evidence for the existence of price pressure effects the results also provide evidence of the very large institutional elasticities of demand for stock in two recent articles in this journal shleifer 1986 and harris and gurel 1986 present important new evidence of the existence of price pressures by examining the price and volume effects associated with changes in the composition of the standard and poor s s p 500 market index specifically these authors interpret the strong increases in trading volume and economically and statistically significant increases decreases in share prices on the first trading day following additions to or deletions from the s p 500 as the result of increased decreased demand by institutional index funds rather than from information effects concerning the future return distributions of the newly listed delisted firms the results of similar price and volume studies conducted by woolridge and ghosh 1986 and lamoureux and wansley 1987 are also generally consistent with the predictions of the price pressure hypothesis while both schleifer 1986 and harris and gurel 1986 suggest that changes in institutional index fund holdings are responsible for the observed abnormal returns in response to s p 500 changes over the years between 1966 and 1983 their joint failure to examine actual institutional ownership changes following listing or delisting from the index does not allow for direct tests of this possibility this study presents results of such tests

motivating and compensating investment advisors this paper considers the problem of how an investor can optimally motivate an investment advisor to exert costly effort to gather valuable investment information we show that compensation schemes that are increasing in the investment payoffs may fail to optimally motivate the advisor we then characterize the conditions under which the private nature of the advisor s acquired information affects how he is optimally motivated to work diligently and present the resulting optimal compensation we establish the conditional optimality of benchmark indexed compensation and provide an explanation to the limited use of such compensation schemes in practice

performance incentive fees an agency theoretic approach this paper employs recent developments in agency theory to study the impact that com pensation contracts have on portfolio management investment decisions in a restricted mean variance world two types of incentive contracts for mutual fund managers are ana lyzed and compared the results show that the symmetric contract while not necessar ily eliminating agency costs dominates the bonus contract in aligning the manager s interests with those ofthe investor investment companies and by extension their managers control a large and increasing percentage ofthe aggregate wealth of their clients more investors are putting their money under the control of these advisers than ever before con sequently potential conflicts of interest arise between investment company own ers and their financial management advisers the securities and exchange com mission sec has been concerned with this issue for a number of years the agency has commissioned several studies to investigate the issue and has set forth certain rulings concerning the behavior of investment company advisers of par ticular importance has been the compensation arrangement between mutual fund management and the fund owners in fact the sec has issued specific guidelines regarding allowable fee schedules for managers these guidelines have ied to a policy debate concerning whether the sec has been too stringent or not stringent enough in regulating compensation for investment managers the present study takes a new approach to this problem in an attempt to resolve this debate the fiduciary relationship between mutual fund management and the inves tors they represent may be viewed as a principal agent relationship conse quently the methodology from the agency literature can be applied to study the impact of various compensation arrangements on the potential conflict of interest between these two groups

incentives and endogenous risk taking a structural view on hedge fund alphas hedge fund managers are subject to several nonlinear incentives performance fee options call equity investors redemption options put and prime broker contracts allowing for forced deleverage put the interaction of these option like incentives affects optimal leverage ex ante depending on the distance of fund value from the high water mark we study how these endogenous effects influence performance measures used in the literature we show that reduced form measures that do not account for these features are subject to economically significant false discovery biases the result is stronger for low quality funds we propose an alternative structural methodology for conducting performance attribution in hedge funds

do option like incentives induce overvaluation evidence from experimental asset markets abstract one potential reason for bubbles evolving prior to the financial crisis was excessive risk taking stemming from option like incentive schemes in financial institutions by running laboratory asset markets we investigate the impact of option like incentives on price formation and trading behavior the main results are that i we observe significantly higher market prices with option like incentives than linear incentives ii we further find that option like incentives provoke subjects to behave differently and to take more risk than subjects with linear incentives iii we finally show that trading at inflated prices is rational for subjects with option like incentives since it increases their expected payout

illiquidity position limits and optimal investment for mutual funds we study the optimal trading strategy of mutual funds that face both position limits and differential illiquidity we provide explicit characterization of the optimal trading strategy and conduct an extensive analytical and numerical analysis of the optimal trading strategy we show that the optimal trading boundaries are increasing in both the lower and the upper position limits we find that position limits can affect current trading strategy even when they are not currently binding and other seemingly intuitive trading strategies can be costly we also examine the optimal choice of position limits

price and volume effects associated with changes in the s p 500 list new evidence for the existence of price pressures attempts to identify price pressures caused by large transactions may be inconclusive if the transactions convey new information to the market this problem is addressed in an examination of prices and volume surrounding changes in the composition of the s p 500 since these changes cause some investors to adjust their holdings of the affected securities and since it is unlikely that the changes convey information about the future prospects of these securities they provide an excellent opportunity to study price pressures the results are consistent with the price pressure hypothesis immediately after an addition is announced prices increase by more than 3 percent this increase is nearly fully reversed after 2 weeks the efficient market hypothesis emh predicts that security prices reflect all publicly available information therefore one corollary of the emh is that you can sell or buy large blocks of stock at close to the market price as long as you can convince other investors that you have no private information 1 this statement assumes that securities are near perfect substitutes for each other if so the excess demand for a single security will be very elastic and the sale or purchase of a large number of shares will have no impact on price in contrast to the emh scholes 8 kraus and stoll 5 hess and frost 4 and others propose two hypotheses which predict that a large stock sale purchase will cause the price to decrease increase even if no new information is associated with the transaction the imperfect substitutes hypothesis ish also known as the distribution effect hypothesis assumes that securities are not close substitutes for each other and hence that long term demand is less than perfectly elastic under this hypothesis equilibrium prices change when demand curves shift to eliminate excess demand price reversals are not expected because the new price reflects a new equilibrium distribution of security holders the price pressure hypothesis pph assumes that investors who accommodate demand shifts must be compensated for the transaction costs and portfolio risks that they bear when they agree to immediately buy or sell securities which they otherwise would not trade these passive suppliers of liquidity are attracted by immediate price drops rises associated with large sales purchases they are compensated for their liquidity service when prices rise drop to their fullinformation levels the pph like the emh assumes that long run demand is

compensation incentives and the duality of risk aversion and riskiness the common folklore that giving options to agents will make them more willing to take risks is false in fact no incentive schedule will make all expected utility maximizers more or less risk averse this paper finds simple intuitive necessary and sufficient conditions under which incentive schedules make agents more or less risk averse the paper uses these to examine the incentive effects of some common structures such as puts and calls and it briefly explores the duality between a fee schedule that makes an agent more or less risk averse and gambles that increase or decrease risk with the growing interest in executive compensation and agency problems

does it all add up benchmarks and the compensation of active portfolio managers in this article the authors examine theoretically the use of benchmark portfolios in the compensation of privately informed portfolio managers they find that the use of a benchmark and particularly the types of benchmarks often observed in practice cannot be easily rationalized specifically commonly used benchmark adjusted compensation schemes are generally inconsistent with optimal risk sharing and do not lead to the choice of an optimal portfolio for the investor moreover benchmarks do not help in solving potential contracting problems such as inducing the manager to expend effort or trying to screen out uninformed managers copyright 1997 by university of chicago press

aggregation and linearity in the provision of intertemporal incentives we consider the problem of providing incentives over time for an agent with constant absolute risk aversion the optimal compensation scheme is found to be a linear function of a vector of n accounts which count the number of times that each of the n kinds of observable events occurs the number n is independent of the number of time periods so the accounts may entail substantial aggregation in a continuous time version of the problem the agent controls the drift rate of a vector of accounts that is subject to frequent small random fluctuations the solution is as if the problem were the static one in which the agent controls only the mean of a multivariate normal distribution and the principal is constrained to use a linear compensation rule if the principal can observe only coarser linear aggregates such as revenues costs or profits the optimal compensation scheme is then a linear function of those aggregates the combination of exponential utility normal distributions and linear compensation schemes makes computations and comparative statics easy to do as we illustrate we interpret our linearity results as deriving in part from the richness of the agent s strategy space which makes it possible for the agent to undermine and exploit complicated nonlinear functions of the accounting aggregates

do demand curves for stocks slope down since september 1976 stocks newly included into the standard and poor s 500 index have earned a significant positive abnormal return at the announcement of the inclusion this return does not disappear for at least ten days after the inclusion the returns are positively related to measures of buying by index funds consistent with the hypothesis that demand curves for stocks slope down the returns are not related to s p s bond ratings which is inconsistent with a plausible version of the hypothesis that inclusion is a certification of the quality of the stock

optimal contracts in a continuous time delegated portfolio management problem this article studies the contracting problem between an individual investor and a professional portfolio manager in a continuous time principal agent framework optimal contracts are obtained in closed form these contracts are of a symmetric form and suggest that a portfolio manager should receive a fixed fee a fraction of the total assets under management plus a bonus or a penalty depending upon the portfolio s excess return relative to a benchmark portfolio the appropriate benchmark portfolio is an active index that contains risky assets where the number of shares invested in each asset can vary over time rather than a passive index in which the number of shares invested in each asset remains constant over time fund managers compensation schemes in a delegated portfolio management setting have been of special interest to both academics and practitioners academic interest stems in part from the rapid growth of managed funds over the last two decades gompers and metrick 1998 report that by december 1996 mutual funds pension funds and other financial intermediaries held discretional control over more than half of the u s equity market it is thus of importance to study the impact of institutional trading on asset prices and to integrate into one model both asset pricing and delegated portfolio management compensation as advocated by brennan 1993 allen and santomero 1997 and allen 2001 it is also important to understand the relationship between a manager s trading strategies and his implicit incentives or career concerns see e g brown harlow and starks 1996 brown goetzmann and park 1997 chevalier and ellison 1999 and chen and pennacchi 2000 these concerns include internal promotion from a small to a large fund higher outside offers and the flow of money through the fund under management 1 the importance of fund manager compensation is also underscored by congressional passage in 1970 of the amendment to

the price response to s p 500 index additions and deletions evidence of asymmetry and a new explanation we study the price effects of changes to the s p 500 index and document an asymmetric price response there is a permanent increase in the price of added firms but no permanent decline for deleted firms these results are at odds with extant explanations of the effects of index changes that imply a symmetric price response to additions and deletions a possible explanation for asymmetric price effects arises from the changes in investor awareness results from our empirical tests support the thesis that changes in investor awareness contribute to the asymmetric price effects of s p 500 index additions and deletions the long held assumption that stocks have perfect substitutes and the perfect elasticity of demand that follows from it is central to modern finance theory if securities have almost perfectly elastic demand then any supply or demand shocks that are devoid of information should have no effect on the prevailing price early empirical research on whether price changes occur in the absence of new information focused on block trades equity issues and stock splits but was unable to exclude information effects around these events since there is no obvious reason to believe ex ante that index changes contain new information they constitute a natural framework for testing whether stocks have almost perfectly elastic or horizontal demand curves a stock s excess return around such changes could be consistent with a downward sloping demand curve with the advent of indexed mutual funds in 1976 and the public announcement of s p index changes in the same year there is much evidence that such announcements are accompanied by an increase in price for firms added to the index if stocks have a short term downward sloping demand curve the price should be momentarily affected by a demand shock due to indexing but that effect

asset pricing under optimal contracts we consider the problem of finding equilibrium asset prices in a financial market in which a portfolio manager agent invests on behalf of an investor principal who compensates the manager with an optimal contract we extend a model from buffa vayanos and woolley 2014 by allowing general contracts and by allowing the portfolio manager to invest privately in individual risky assets or the index to alleviate the effect of moral hazard agent is optimally compensated by benchmarking to the index which however may incentivize him to be too much of a closet indexer to counter those incentives the optimal contract rewards agent for taking specific risk of individual assets in excess of the systematic risk of the index by rewarding the deviation between the portfolio return and the return of an index portfolio and the deviation s quadratic variation

the delegated lucas tree we analyze the effects of the observed increased share of delegated capital for trading strategies and equilibrium prices by introducing delegation into a standard lucas exchange economy in equilibrium some investors trade on their own account but others decide to delegate trading to professional fund managers flow performance incentive functions describe how much capital clients provide to funds at each date as a function of past performance convex flow performance relations imply that the average fund outperforms the market in recessions and underperforms in expansions when the share of capital that is delegated is low all funds follow the same strategy however when the equilibrium share of delegated capital is high funds with identical incentives employ heterogeneous trading strategies a group of managers borrows to take on a levered position on the stock thus fund returns are dispersed in the cross section and the outstanding amounts of borrowing and lending increase the relation between the share of delegated capital and the sharpe ratio typically follows an inverse u shaped pattern jel g11 g12 g23 d02 d81 over the past thirty years there has been a gradual but profound change in the way money is invested in financial markets while almost 50 of u s equities were held directly in 1980 by 2007 this proportion decreased to approximately 20 see french 2008 what are the equilibrium implications of this shift in particular how does the increased presence of delegation affect trading strategies and prices to analyze the link between the incentives of financial institutions and asset prices we introduce financial intermediaries into a lucas exchange economy rather than study an optimal contracting problem we rely on empirical regularities inflows and assume a convex relation betweenflows and performance relative to the market as documented for example in chevalier and ellison 1997

capital immobility and the reach for yield abstract i build a model in which financial intermediation slows down capital flows investors optimally learn from intermediary performance to allocate capital toward profitable intermediaries intermediaries reach for yield i e they invest in high tail risk assets in an attempt to drive flows and reduce liquidation risk intermediaries with strong opportunities face a trade off between choosing a portfolio that maximizes profitability and choosing one that maximizes the speed at which capital flows in equilibrium reaching for yield is stronger among intermediaries with weak opportunities resulting in a reduction in the informativeness of performance investors thus take longer to learn and capital flows become less responsive to performance capital becomes slow moving because the reach for yield dampens learning the model predicts capital immobility to be stronger when tail risk is high when tail risk is under priced and in asset classes with large cross sectional variation in tail risk exposures

competition in portfolio management theory and experiment we explore theoretically and experimentally the general equilibrium price and allocation implications of delegated portfolio management when the investor manager relationship is nonexclusive our theory predicts that competition forces managers to promise portfolios that mimic arrow debreu ad securities which investors then combine to fit their preferences a weak version of the capital asset pricing model capm obtains where state prices relative to state probabilities implicit in prices of traded securities will be inversely ranked to aggregate wealth across states our experiment broadly corroborates the price and choice predictions of the theory however price quality deteriorates when only a few managers attract most of the available wealth wealth concentration increases because funds flow toward managers who offer portfolios closer to replicating ad securities as in the theory but also because funds flow to managers who had better performance in the immediate past an observation unrelated to the theory this paper was accepted by jerome detemple finance

portfolio performance and agency the evaluation and compensation of portfolio managers is an important problem for practitioners optimal compensation will induce managers to expend eort to generate information and to use it appropriately in an informed portfolio choice our general model points the way towards analysis of optimal performance evaluation and contracting in a rich model optimal contracting in the model includes an important role for portfolio restrictions that are more complex than the sharing rule the agent s compensation gives the agent approximately to a benchmark return plus an incentive fee equal to a portfolio measure that is approximately the excess of return above the benchmark this measure is often used by practitioners but is simpler than the jensen measure and other measures commonly recommended in the academic literature in addition to the excess return above the xed benchmark the manager is given some additional incentive to take a position that deviates from the benchmark to remove an incentive to tend towards being a closet indexer ecient contracting involves restrictions on what portfolio strategies can be pursued and prior communication of the information gathered

does option compensation increase managerial risk appetite this paper solves the dynamic investment problem of a risk averse manager compensated with a call option on the assets he controls under the manager s optimal policy the option ends up either deep in or deep out of the money as the asset value goes to zero volatility goes to infinity however the option compensation does not strictly lead to greater risk seeking sometimes the manager s optimal volatility is less with the option than it would be if he were trading his own account furthermore giving the manager more options causes him to reduce volatility managers with convex compensation schemes play an important role in financial markets this paper solves for the optimal dynamic investment policy for a risk averse manager paid with a call option on the assets he controls the paper focuses on how the option compensation impacts the manager s appetite for risk when he cannot hedge the option position on one hand the convexity of the option makes the manager shun payoffs that are likely to be near the money under the optimal policy the manager either significantly outperforms his benchmark or else incurs severe losses furthermore in examples of optimal trading strategies asset volatility goes to infinity as asset value goes to zero yet option compensation does not strictly lead to greater risk seeking as asset value grows large or if the evaluation date is far away the manager moderates asset risk for example if the manager has constant relative risk aversion crra asset volatility converges to the merton constant as asset value goes to infinity in some situations the manager actually chooses a lower asset volatility than he would if he were investing on his own because the leverage inherent in his option magnifies his exposure to the asset volatility in addition with all constant or decreasing absolute risk averse utility functions from the hyperbolic absolute risk averse hara class giving the manager more options causes him to reduce asset volatility in the crra case for example the manager targets a fixed volatility for his personal