Asset Bubbles: Re-thinking Policy for the Age of Asset Management
IMF Working Papers, February 11, 2015
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- Asset Bubbles: Re-thinking Policy for the Age of Asset Management
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Bibliographic details
- Authors: Bradley Jones
- Published: February 11, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475576207.001
Summary
- The paper synthesizes a broad literature across the rational—irrational divide to explain why asset bubbles continue to threaten economic stability despite markets becoming more informationally-efficient, more complete, and more heavily influenced by sophisticated (i.e. presumably rational) institutional investors.
- Candidate explanations for bubble persistence examined include limits to learning, frictional limits to arbitrage, and behavioral errors; these are judged unsatisfactory because they conflict with the trends affecting global capital markets described above.
- The author emphasizes the short-term nature of the asset owner—manager relationship and the momentum bias inherent in financial benchmarks as critical factors shaping asset manager behavior.
- The central argument: the business risk of asset managers provides strong motivation for institutional herding and what the author terms “rational bubble-riding.”
Key Findings
- Institutional herding and rational bubble-riding are driven by the business risk faced by asset managers linked to principal-agent dynamics and benchmark-related incentives.
- Traditional explanations (limits to learning, frictional limits to arbitrage, behavioral errors) are inconsistent with increased market informational efficiency, market completeness, and greater influence of institutional investors.
- Procyclicality may intensify as institutional assets under management continue to grow.
Policy Implications and Recommendations
- Remedial policies should extend beyond standard macroprudential and monetary measures to include time-invariant policies targeted at the root causes rather than only the symptoms of asset bubbles.
- Prominent policy reforms recommended:
- Reforms addressing principal-agent contract design.
- Reforms related to the implementation of financial benchmarks.
- Anticipated policy consequence: without addressing contract design and benchmark implementation, the growth of institutional assets under management could amplify procyclicality.
Subject Coverage and Keywords
- Subject: Asset and liability management; Asset bubbles; Asset management; Asset prices; Financial crises; Financial markets; Financial sector policy and analysis; Financial sector stability; Prices; Stock markets.
- Keywords include: asset boom; asset bubble; asset bubble model; Asset management; asset market; asset price; asset price determination; asset price inflation; asset price movement; Asset prices; bubble model; cost of capital; earnings yield; Financial sector stability; Financial stability; Global; Macroprudential policy; market capitalization; monetary policy; Stock markets; valuation misalignment; WP.