Institutional benchmarking and equilibrium asset pricing
In this thesis we develop an asset pricing model with heterogeneous institutional investors, and we provide a comprehensive analysis of the effects of benchmark heterogeneity on equilibrium prices and portfolio allocations. We find that an institution’s holdings are higher for those assets that are exclusively part of its benchmark, are negative for those assets that are in the other institution’s benchmarks and are zero for the risk free asset. These results imply that correlation across benchmarks is negative. We define a measure of asymmetry between benchmarks and show how it affects asset prices and portfolio allocations. Institutions revert their holdings to their benchmarks when fundamental volatility is high – flight to benchmark – thus creating a demand pressure on the overlapping part of benchmarks, which in turn pushes prices up and market prices of risk down even further. Our model also allows to study the twin stocks discrepancy, the low volatility puzzle and the asset class effect. We conclude our analysis by characterizing an endogenous choice of benchmark, and show that institutions optimally select the same fully diversified index.