Asset Prices and Institutional Investors

Download or read book Asset Prices and Institutional Investors written by Suleyman Basak and published by . This book was released on 2012 with total page 0 pages. Available in PDF, EPUB and Kindle. Book excerpt: 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.