#06-04
Asset Prices when Agents are Marked-to-Market
Gary B. Gorton and Ping He, January 2006
Abstract: "Risk management" in securities markets refers to the oversight of portfolio managers and professional traders when they trade on behalf of investors in security markets. Monitoring of their trading performance is usually based on "marking-to-market," that is, the agent's performance, profit and loss, and risk-taking behavior, is measured by principals using market security prices. We study the optimality of the practice of marking-to-market and provide conditions under which investing principals should optimally monitor their agent traders using market prices to measure the traders' performance. Asset prices, however, can be affected by mark-to-market contracts. We show that such contracts introduce an externality when there are many traders. Traders may rationally herd, trading on irrelevant information. Ironically, this causes asset prices to be less informative than they would be without the agency problem.
Keywords:
JEL classifications :
