Riding the bubble with convex incentives

Juan Sotes-Paladino, Fernando Zapatero

Resultado de la investigación: Contribución a una revistaArtículorevisión exhaustiva

1 Cita (Scopus)

Resumen

We show that benchmark-linked convex incentives can lead risk-averse money managers aware of mispricing to overinvest in overpriced securities. In the model, the managers' risk-seeking behavior varies in response to the interaction of mispricing with convexity and benchmarking concerns. Convexity effects can exacerbate the manager's overinvestment in overvalued nonbenchmark securities. In contrast, they potentially offset the benchmarking effects studied in the literature, leading to underinvestment in overpriced benchmark securities. Under correlated mispricing across assets, our model rationalizes positive positions in nonbenchmark, negative risk premium (i.e., “bubble”) securities and “pairs trading” in two overvalued securities. Our findings help explain several empirical puzzles.

Idioma originalInglés
Páginas (desde-hasta)1416-1456
Número de páginas41
PublicaciónReview of Financial Studies
Volumen32
N.º4
DOI
EstadoPublicada - 1 abr 2019
Publicado de forma externa

Nota bibliográfica

Publisher Copyright:
© The Author(s) 2018. Published by Oxford University Press on behalf of The Society for Financial Studies.

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