Price Co-Movements and Investment Funds

• Departmental Seminar

Date and Location

Monday, February 2, 2015, 3:30 PM - 5:00 PM
3001 Plant and Environmental Sciences

Abstract

This paper discusses price co-movements between fundamentally independent financial markets populated by risk neutral global funds and specialized funds. The investment decisions are delegated to risk neutral fund managers who are informed or uninformed of the state of the markets and have reputational concerns. We show that in any equilibrium of the model, prices of the risky assets co-move with each other following any shock to ex-ante probabilities of default. The mechanism that generates this co-movement relies on two sources: the information asymmetry between fund managers and the reputational concerns of uninformed fund managers facing the threat of dismissal. The reputational channel reinforces the co-movement but it is not necessary to generate it. Information asymmetry induces co-movement even in the absence of reputational concerns.