Fund flows and asset prices: a baseline model

We study flows between investment funds and their effects on asset prices in a simple twoperiod version of Vayanos and Woolley (2010, VW). As in VW, flows cause assets to comove in ways unrelated to fundamentals, affect assets with high idiosyncratic risk the most, and raise the expected returns of funds experiencing outflows. We sketch how adding periods can generate other results of VW such as momentum, reversal, amplification, and commercial-risk management. We also extend the VW framework to study how index redefinitions affect the price level and the extent of comovement. This is a revised version of Working Paper Series No 15, FMG Discussion Paper No 662.