Three Essays on Information Economics and Delegated Portfolio Management
Creators: name: Malikov, George
Publisher: name: My University
Year: 2021
Subjects: subject: delegated portfolio management
subject: information acquisition
subject: passive investing
subject: quantitative investing
subject: ETF
subject: Finance
subject: Business and Economics

description: This dissertation studies the implications of technological innovation in the financial markets to asset prices, market quality, and the delegated portfolio management sector. Three such developments are considered: index funds (Chapter 1), quantitative mutual funds (Chapter 2), and exchange traded products (Chapter 3). For index funds, I study the drivers of the growth in passive investing and its effect on market efficiency. For quantitative mutual funds and exchange traded products, I explore their impact on various measures of market quality such as price discovery, market efficiency, and liquidity. Chapter 1 investigates the impact of fundamental information acquisition costs on price informativeness and passive investing. Within a noisy rational expectations equilibrium (REE) model of multiple risky assets and a redundant market index, I define passive investing as the optimal decision to: 1) free-ride on the information acquisition efforts of active traders in the index asset, and 2) forgo all stock picking strategies. Falling information costs have the dual effect of lowering the cost of market timing, decreasing passive share, and lowering the cost of stock picking, increasing passive share. If the stock picking effect dominates the market timing effect, passive share increases in tandem with greater price informativeness. I exploit the Security and Exchange Commission's eXtensible Business Reporting Language mandate as a negative shock to information costs to provide suggestive evidence that falling information costs may be contributing to the rise in passive investing. Chapter 2, joint with Paolo Pasquariello, studies the effects of quantitative equity investing, an increasingly popular investment style, on financial market quality. Within a noisy REE model of strategic speculation with two informed market participants, we define discretionary investing as fully strategic trading and quantitative investing as partially or fully myopic via its reliance on a backtested trading strategy. Growth in quantitative investing is modeled as both the introduction of and the greater backtest adherence by an informed speculator. The introduction of an additional speculator generally benefits financial market quality. The effect of greater backtest adherence depends on whether it leads to more or less aggressive trading than discretion, the former improving, while the latter worsening market quality. If it is more aggressive, market quality broadly benefits with greater quantitative investing; if it is less aggressive, market quality deteriorates. Chapter 3 explores the implications of the growth in exchange traded funds (ETFs) and the associated arbitrage trading on price discovery and market liquidity. The introduction of arbitrage trading to segmented markets with otherwise diverging prices averages noise trading across markets, as the arbitrageur buys (sells) in the market with excess noise supply (demand). This smoothing results in less informed trading due to lower camouflage for the speculators, and lower liquidity due to greater adverse selection concerns for the market makers. The introduction of an ETF that attracts a threshold level of incremental noise trading leads to unambiguous improvements in the market quality of the underlying security, as the arbitrageur connects the synthetic and underlying markets by averaging noise trading across markets. I highlight the differential effects on market quality of stand-alone arbitrageurs and market makers jointly serving as arbitrageurs, with the former leading to greater informed trading intensity for the speculators and greater adverse selection for the market makers, and the latter having the opposite effect.