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In distilling a vast literature spanning the rational— irrational divide, this paper offers reflections on why asset bubbles continue to threaten economic stability despite financial markets becoming more informationally-efficient, more complete, and more heavily influenced by sophisticated (i.e. presumably rational) institutional investors. Candidate explanations for bubble persistence—such as limits to learning, frictional limits to arbitrage, and behavioral errors—seem unsatisfactory as they are inconsistent with the aforementioned trends impacting global capital markets. In lieu of the short-term nature of the asset owner—manager relationship, and the momentum bias inherent in financial benchmarks, I argue that the business risk of asset managers acts as strong motivation for institutional herding and ‘rational bubble-riding.’ Two key policy implications follow. First, procyclicality could intensify as institutional assets under management continue to grow. Second, remedial policies should extend beyond the standard suite of macroprudential and monetary measures to include time-invariant policies targeted at the cause (not just symptom) of the problem. Prominent among these should be reforms addressing principal-agent contract design and the implementation of financial benchmarks.

Asset-liability management. --- Economic policy. --- Financial risk management. --- Monetary policy. --- Finance --- Business & Economics --- Banking --- Economic nationalism --- Economic planning --- National planning --- State planning --- Monetary management --- Asset-liability management (Banking) --- Funds management --- Economics --- Planning --- National security --- Social policy --- Economic policy --- Currency boards --- Money supply --- Risk management --- Financial institutions --- Management --- Investments --- Asset-liability management --- Financial risk management --- Monetary policy --- E-books --- Finance: General --- Financial Risk Management --- Macroeconomics --- Financial Markets and the Macroeconomy --- Central Banks and Their Policies --- Financial Crises --- Information and Market Efficiency --- Event Studies --- International Financial Markets --- General Financial Markets: Government Policy and Regulation --- Price Level --- Inflation --- Deflation --- General Financial Markets: General (includes Measurement and Data) --- Economic & financial crises & disasters --- Asset prices --- Asset bubbles --- Asset management --- Financial sector stability --- Stock markets --- Prices --- Financial crises --- Asset and liability management --- Financial sector policy and analysis --- Financial markets --- Financial services industry --- Stock exchanges --- United States

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Do portfolio shifts by the world’s largest asset owners respond procyclically to past returns, or countercyclically to valuations? And if countercyclical investment (with both market-stabilizing and return-generating properties) is a public and private good, how might asset owners be empowered to do more of it? These two questions motivate this study. Based on analysis of representative portfolios (totaling $24 trillion) for a range of asset owners (central banks, pension funds, insurers and endowments), portfolio changes typically appear procyclical. In response, I suggest a framework aimed at jointly bolstering long-term returns and financial stability should: (i) embed governance practices to mitigate ‘multi-year return chasing;’ (ii) rebalance to benchmarks with factor exposures best suited to long-term investors; (iii) minimize principal-agent frictions; (iv) calibrate risk management to minimize long-term shortfall risk (not short-term price volatility); and (v) ensure regulatory conventions do not amplify procyclicality at the worst possible times.

Asset allocation. --- Business cycles. --- Financial risk management. --- Risk management --- Economic cycles --- Economic fluctuations --- Cycles --- Allocation of assets --- Investments --- Portfolio management --- Finance: General --- Financial Risk Management --- Investments: Stocks --- Public Finance --- Portfolio Choice --- Investment Decisions --- Pension Funds --- Non-bank Financial Institutions --- Financial Instruments --- Institutional Investors --- Financial Institutions and Services: Government Policy and Regulation --- International Financial Markets --- Social Security and Public Pensions --- General Financial Markets: Government Policy and Regulation --- Finance --- Pensions --- Investment & securities --- Asset allocation --- Asset management --- Pension spending --- Stocks --- Financial sector stability --- Asset and liability management --- Expenditure --- Financial institutions --- Financial sector policy and analysis --- Asset-liability management --- Financial services industry --- United States

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Aerodynamics --- Aérodynamique

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