Two essays on mutual funds

This thesis includes two essays which analyze portfolio selection and equilibrium asset prices in an economy where trades happen through a manager hired by investors to act on their behalf.; This first essay studies a fund manager's implicit incentives and their impact on the manager's trading behavior. The manager's implicit incentives arise from the fact that his performance in the current period influences his reservation wage as well as the fund's inflows in the next period. Under certain conditions, optimal contracts and optimal portfolio policies are derived in closed form. The optimal policy comprises two components: an actively managed component and a herd component that mimics the benchmark policy against which the manager's performance is measured. We show that the incentive to herd decreases with the manager's age and the fund expenses. We also find that the risk associated with the actively managed component of the portfolio increases with the manager's age and the fund expenses. Moreover, the model implies that the manager has an incentive to increase the risk of the actively managed component of his portfolio towards the end of any period. Using domestic equity funds data from 1996 to 1999, we test the model and find empirical evidence in support of the model's implications. Our results are robust to some of the measures of herding used in the literature.; Previous analyses of equilibrium asset prices often ignore the effects of delegated portfolio management and those of delegated portfolio management problems often ignore differential information and equilibrium asset prices. The second essay develops a dynamic model that simultaneously considers optimal contracting and equilibrium asset prices under differential information. Optimal contracts and equilibrium asset prices are explicitly characterized. Using the results from the model, we examine the impact of portfolio delegation and risk sharing on portfolio managers' trading behavior, the autocorrelation in stock returns, and the persistence of fund performance. Optimal risk sharing and the costs associated with managing the portfolio have significant effects on prices, demands, excess returns, and autocorrelations. Risk sharing reduces autocorrelations while the costs enhance them.