Asset pricing based on the relationship of principal-agent

There is moral hazard when the portfolio management is delegated. The compensation contracts chosen by each investor (principal) and manager (agent) can have effect on the asset equilibrium prices. 'We assume that there are only two representative investors, a representative individual investor and a representative institutional investor who manage the asset of the principal in a frictionless financial market. All the investors are risk averse. The representative individual investor selects his own optimal portfolio according to the mean-variance model, and the representative institutional investor selects his own optimal portfolio according to, his incentive fee. We drive, a two-factor asset pricing model when the market is clearing. We analyze how the ratio of different investors and how the incentive fees of managers affect the asset price. We show that the CAPM linear relation still holds in the presence of delegated portfolio management and that there are three betas in our asset pricing model where benchmark risk is priced. This paper illustrates that, in the presence of delegated portfolio management, contracting plays a key role in the determination of the expected return of a stock.