We consider thin incomplete financial markets, where traders with heterogeneous preferences and risk exposures have motive to behave strategically regarding the demand schedules they submit, thereby impacting prices and allocations. We argue that traders relatively more exposed to market risk tend to submit more elastic demand functions. Noncompetitive equilibrium prices and allocations result as an outcome of a game among traders. General sufficient conditions for existence and uniqueness of such equilibrium are provided, with an extensive analysis of two-trader transactions. Even though strategic behaviour causes inefficient social allocations, traders with sufficiently high risk tolerance and/or large initial exposure to market risk obtain more utility gain in the noncompetitive equilibrium, when compared to the competitive one.
We build an active asset management model to study the interplay between the career concerns of a manager and prevailing market conditions. We show that fund managers overinvest in market‐neutral strategies, as these have a reputational benefit. This benefit is smaller in bull markets, when investors expect more managers to use high‐beta strategies, making their performance less informative about their ability than in bear markets. Consequently, fund flows that follow high‐beta strategies are less responsive to the fund's performance, and flow‐performance sensitivity is higher in bear markets than in bull markets.
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