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Fund flows and asset prices: a baseline model

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We study flows between investment funds and their effects on asset prices in a simple two- period version of Vayanos and Woolley (2010, VW). As in VW, flows cause assets to comove in ways unrelated to fundamentals, affect assets with high idiosyncratic risk the most, and raise the expected returns of funds experiencing outflows. We sketch how adding periods can generate other results of VW such as momentum, reversal, amplification, and fund managers’ willingness to hedge against commercial risk. We also extend the VW framework to study how changes in index weights affect the price level and the extent of comovement.

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en

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http://eprints.lse.ac.uk/29784/

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