Reputational Concerns and Price Comovements

Abstract

We analyze the rational expectation equilibria of a delegated portfolio management model in which two risky assets have completely independent returns and liquidity shocks. Some managers have perfect information on the assets' returns while others are uninformed and try to infer information from the prices. We show that, as long as some reasonable assumptions on the nature of the equilibrium are imposed, in a rational expectations equilibrium there is always a set of realizations of the shocks such that the returns are not revealed. In this region the prices of the two assets exhibit a strong form of comovement, as they must be identical. This occurs despite the fact that the two assets have different ex ante probabilities of repayment.