Finance Theory Group

Finance Theory Insights

  • Issue 4 (September 2023)
  • Issue 3 (May 2023)
  • Issue 2 (May 2022)
  • Issue 1 (September 2021)

Unexpected Consequences of Financial Contracts

Financial contracts are often designed to mitigate conflicts of interest between different parties. Their features, and more broadly tradability of financial securities, can give rise to unexpected outcomes. "Asset Management Contracts and Equilibrium Prices" shows that constraining asset managers to hold portfolios close to the benchmark indices against which they will be evaluated amplifies any mispricing in the underlying assets, and the aggregate market becomes overvalued. "Why Aren’t Mortgages Indexed to House Prices?" examines the curious absence of mortgage loans indexed to house prices, and singles out as a culprit the benefit that lenders obtain from basing such loans on low-quality house price indices. "Trading and Shareholder Democracy" highlights that not only can shareholder voting result in inefficient outcomes, just like voting in a political context, but tradability of shares before a corporate election can in fact make the situation even worse. Finally, "A Theory of Liquidity Spillover between Bond and CDS Markets" points to unexpected positive effects of naked CDS trades on the market for the underlying bonds---the bonds become more liquid, and their price also improves.