Institutional Investors, Heterogeneous Benchmarks and the Comovement of Asset Prices

We study the equilibrium implications of an economy in which asset managers are each subject to a different benchmark. We demonstrate how heterogeneous benchmarking endogenously generates a mechanism through which fundamental shocks propagate across assets. Heterogeneous benchmarking reduces short-run return correlation, and may even lead to negative asset comovement. An asset that is included in a benchmark can not only become negatively correlated with assets included in a different benchmark, but also with assets belonging to the same benchmark. Our results are in line with the weakened comovement across industry-sector portfolios and investment styles over short horizons, and provide new testable implications on the established “asset-class” effect. The presence of institutional investors with different benchmarks also triggers additional price pressure amplifying return volatility. Our setting is tractable and we obtain our results in closed-form. ∗Contacts: [email protected] and [email protected]. We thank Suleyman Basak, Ron Kaniel, Ellen Paulus, Anna Pavlova, Fernando Zapatero, seminar participants at Hebrew University, University of Colorado Boulder, Stockholm School Economics, University of Texas at Austin, and conference participants at Northeastern University Finance Conference for helpful comments and discussions.