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Theses Doctoral

Three Essays on Asset Pricing

An, Byeongje

The first essay examines the joint determination of the contract for a private equity (PE) fund manager and the equilibrium risk premium of the PE fund. My model relies on two realistic features of PE funds. First, I model agency frictions between PE fund's investors and manager. Second, I model the illiquidity of PE fund investments. To alleviate agency frictions, compensation to the manager becomes sensitive to the PE fund performance, which makes investors excessively hold the PE fund to hedge the manager's fees. This induces a negative effect on the risk premium in equilibrium. For the second feature, I add search frictions in the secondary market for PE fund's shares. PE fund returns also contain a positive illiquidity premium since investors internalize the possibility of holding sub-optimal positions in the PE fund. Thus, my model delivers a plausible explanation for the inconclusive findings of the empirical literature regarding PE funds' performance. Agency conflicts deliver a lower risk-adjusted performance of PE funds, while illiquidity risk can raise it.
In the second essay, coauthored with Andrew Ang and Pierre Collin-Dufresne, we investigate how often investors should adjust asset class allocation targets when returns are predictable and updating allocation targets is costly. We compute optimal tactical asset allocation (TAA) policies over equities and bonds. By varying how often the weights are reset, we estimate the utility costs of different frequencies of TAA decisions relative to the continuous optimal Merton (1971) policy. We find that the utility cost of infrequent switching is minimized when the investor updates the target portfolio weights annually. Tactical tilts taking advantage of predictable stock returns generate approximately twice as much value as those market-timing bond returns.
In the third essay, also coauthored with Andrew Ang and Pierre Collin-Dufresne, we revisit the question of a pension sponsor's optimal asset allocation in the presence of a downside constraint and the possibility for the pension sponsor to contribute money to the pension plan. We analyze the joint problem of optimal investing and contribution decisions, when there is disutility associated with contributions. Interestingly, we find that the optimal portfolio decision often looks like a ``risky gambling" strategy where the pension sponsor increases the pension plan's allocation to risky assets in bad states. This is very different from the traditional prediction, where in economy downturns the pension sponsor should fully switch to the risk-free portfolio. Our solution method involves a separation of the pension sponsor's problem into a utility maximization problem and a disutility minimization one.

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More About This Work

Academic Units
Business
Thesis Advisors
Ang, Andrew
Degree
Ph.D., Columbia University
Published Here
October 22, 2017