Do convex incentives boost asset prices and volatility?: Based on the perspective of investors' heterogeneous beliefs
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1.School of Statistics, Jiangxi University of Finance and Economics;2.Jiangxi University of Finance and Economics

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    Abstract:

    This paper analyzes the impact of convex incentives in delegated portfolio management to prices and volatility of the risky assets by using a theoretical model in continuous-time financial framework. First of all, we establish a multiple-stock dynamic equilibrium pricing model in which the institutional and retail investors have heterogeneous beliefs, and the institutional investors facing convex incentives which are associated with a benchmark portfolio's performance. Secondly, using the martingale method, we derive closed-form solutions for the risky asset’s equilibrium price and volatility. Finally, numerical results show that the stock in benchmark portfolio has higher price and volatility than the stock not in. The convex incentives to institutional investors can always boost the risky asset prices and the volatility of stock in benchmark portfolio. When institutional investors are more pessimistic than retail investors, the increase of convex incentives will reduce the volatility of the stock not in benchmark portfolio, and the increase of institutional market share will reduce the degree of bubble of stock not in benchmark portfolio.

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History
  • Received:March 25,2021
  • Revised:June 30,2022
  • Adopted:July 02,2022
  • Online: August 02,2022
  • Published:
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