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RFS Advance Access originally published online on May 25, 2005
Review of Financial Studies 2005 18(4):1253-1303; doi:10.1093/rfs/hhi025
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© The Author 2005. Published by Oxford University Press. All rights reserved. For Permissions, please email: journals.permissions@oupjournals.org

An Equilibrium Model of Asset Pricing and Moral Hazard

Hui Ou-Yang
Duke University

Address correspondence to Hui Ou-Yang, Fuqua School of Business, Duke University, Durham, NC 27708-0120, e-mail: huiou{at}duke.edu.

This article develops an integrated model of asset pricing and moral hazard. It is demonstrated that the expected dollar return of a stock is independent of managerial incentives and idiosyncratic risk, but the equilibrium price of the stock depends on them. Thus, the expected rate of return is affected by managerial incentives and idiosyncratic risk. It is shown, however, that managerial incentives and idiosyncratic risk affect the expected rate of return through their influence on systematic risk rather than serve as independent risk factors. It is also shown that the risk aversion of the principal in the model leads to less emphasis on relative performance evaluation than in a model with a risk-neutral principal.


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