Fund flows inducing mispricing of risk in competitive financial markets

Axel Stahmer
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Axel Stahmer: ESMT European School of Management and Technology

No ESMT-15-04, ESMT Research Working Papers from ESMT European School of Management and Technology

Abstract: This paper studies the effect of new fund flows on investment behavior and the resulting equilibrium price of risk. The Small Fund Industry model shows equilibria with overinvestment in unprofitable and underinvestment in profitable investment opportunities. The Large Fund Industry model derives market prices for risk and analyzes the resulting price distortions in equilibrium. New flow of funds to the asset management industry lead to inefficient investment decisions, mispricing of risk, and distortion of market implied probabilities. Furthermore, the paper provides an explanation for partial market failure and trade among identical asset managers without assuming heterogeneous beliefs.

Keywords: Asset pricing; mutual funds; flow of funds; mispricing; misallocation of capital; overinvestment; underinvestment; investment decision; implied probabilites (search for similar items in EconPapers)
Pages: 39 pages
Date: 2015-11-27
New Economics Papers: this item is included in nep-fmk
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http://static.esmt.org/publications/workingpapers/ESMT-15-04.pdf First version, 2015 (application/pdf)

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Persistent link: https://EconPapers.repec.org/RePEc:esm:wpaper:esmt-15-04

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