Abstract: This paper develops a model of active portfolio management in which fund managers may secretly gamble in order to manipulate their reputation and attract more funds. We show that such trading strategies may expose investors to severe losses and are more likely to occur when fund managers are impatient, their trading skills are scalable and generate higher profit per unit of risk. We study investment management contracts that deter this behavior. If investors are short-lived, then the manager must leave rents to investors in order to credibly commit not to gamble. If investors are long-lived, contracts that increase but defer expected bonuses after an outstanding performance implement the first-best. Our model can explain a number of observed differences in performance between mutual and hedge funds. In particular, it explains why persistence in net risk-adjusted returns can be higher for hedge funds, and offers a rationale for the prevalence of high-water mark contracts.
Abstract: This paper develops an equilibrium model of a subprime mortgage market. The model is analytically tractable and delivers plausible orders of magnitude for borrowing capacities,loan-to-income ratios, home prices, and default and trading intensities. We offer simple explanations for several phenomena in the subprime market, such as the prevalence of “teaser rates” and the clustering of defaults. In our model, the degree of income co-movement among households plays an important role. We find that both systematic and idiosyncratic income risks reduce debt capacities, although through quite distinct channels, and that debt capacities and home prices need not be higher when a larger fraction of income risk is idiosyncratic.
Abstract: We study rational expectation equilibria (REE) in dynamic asset pricing models with heterogeneously informed agents. The contribution of the paper is twofold. First, we show that under mild conditions the state space of such models can be infinite dimensional. This result indicates that the domain of analytically tractable dynamic models with asymmetric information is severely restricted. Second, we demonstrate that even though dynamics of stochastic supply place significant restrictions on the possible sign of return autocorrelations, under some circumstances asymmetric information can generate positive autocorrelation in REE.
Sources of Systematic Risk, (with D. Papanikolaou). [Latest version January 2009]. Winner of Crowell Memorial Prize (second place), PanAgora Asset Management, 2007.
Abstract: Using the restrictions implied by the heteroskedasticity of stock returns, we identify four factors in the U.S. industry returns. The first correlates highly with the market portfolio; the second is a portfolio of stocks that produce investment goods minus stocks that produce consumption goods; the third differentiates between cyclical and noncyclical stocks. The fourth, a portfolio of industries that produce input goods minus the rest of the market, is a robust predictor of excess returns on the market portfolio and bond returns. The extracted factors are shown to contain significant information about future macroeconomic and financial variables.
