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Relative Performance, Risk and Entry in the Mutual Fund Industry

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Author Info

  • Gyongyi Loranth

    (Judge Business School, University of Cambridge)

  • Emanuela Sciubba

    (Birkbeck, University of London)

Abstract

This paper analyses the impact of the emergence of new funds on the portfolio decisions of mutual fund managers who are evaluated on the basis of relative performance within a dynamic model. Recent theoretical literature has pointed to the inefficiencies in portfolio selection caused by relative performance evaluation of fund managers. We find that the on-going process of creation of new funds, by posing an entry threat to the incumbent fund managers, greatly alleviates these inefficiencies. Hence the transitory market structure that characterises the mutual fund industry could explain why relative performance evaluation is widely in use.

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Bibliographic Info

Article provided by De Gruyter in its journal The B.E. Journal of Economic Analysis & Policy.

Volume (Year): topics.6 (2006)
Issue (Month): 1 ()
Pages: 19

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Handle: RePEc:bpj:bejeap:v:topics.6:y:2006:i:1:n:19

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Related research

Keywords: relative performance evaluation; fund management industry; ranking objectives; family of funds;

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References

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  1. Goriaev, A.P. & Nijman, T.E. & Werker, B.J.M., 2005. "Yet another look at mutual fund tournaments," Open Access publications from Tilburg University urn:nbn:nl:ui:12-167598, Tilburg University.
  2. Meyer, Margaret A & Vickers, John, 1995. "Performance Comparisons and Dynamic Incentives," CEPR Discussion Papers 1107, C.E.P.R. Discussion Papers.
  3. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  4. Judith A. Chevalier & Glenn D. Ellison, 1995. "Risk Taking by Mutual Funds as a Response to Incentives," NBER Working Papers 5234, National Bureau of Economic Research, Inc.
  5. Goriaev, Alexei P. & Palomino, Frédéric & Prat, Andrea, 2001. "Mutual Fund Tournament: Risk Taking Incentives Induced By Ranking Objectives," CEPR Discussion Papers 2794, C.E.P.R. Discussion Papers.
  6. Luís M. B. Cabral, 2003. "R&D Competition when firms Choose Variance," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 12(1), pages 139-150, 03.
  7. Ahmed, Parvez, 2001. "Forecasting correlation among equity mutual funds," Journal of Banking & Finance, Elsevier, vol. 25(6), pages 1187-1208, June.
  8. Erik R. Sirri & Peter Tufano, 1998. "Costly Search and Mutual Fund Flows," Journal of Finance, American Finance Association, vol. 53(5), pages 1589-1622, October.
  9. Hans K. Hvide, 2002. "Tournament Rewards and Risk Taking," Journal of Labor Economics, University of Chicago Press, vol. 20(4), pages 877-898, October.
  10. Emanuela Sciubba, 2000. "Relative Performance and Herding in Financial Markets," Econometric Society World Congress 2000 Contributed Papers 1570, Econometric Society.
  11. Palomino, Frederic, 2005. "Relative performance objectives in financial markets," Journal of Financial Intermediation, Elsevier, vol. 14(3), pages 351-375, July.
  12. Khorana, Ajay & Servaes, Henri, 1999. "The Determinants of Mutual Fund Starts," Review of Financial Studies, Society for Financial Studies, vol. 12(5), pages 1043-74.
  13. Busse, Jeffrey A., 2001. "Another Look at Mutual Fund Tournaments," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(01), pages 53-73, March.
  14. Taylor, Jonathan, 2003. "Risk-taking behavior in mutual fund tournaments," Journal of Economic Behavior & Organization, Elsevier, vol. 50(3), pages 373-383, March.
  15. Brown, Keith C & Harlow, W V & Starks, Laura T, 1996. " Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 51(1), pages 85-110, March.
  16. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  17. Mookherjee, Dilip, 1984. "Optimal Incentive Schemes with Many Agents," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 433-46, July.
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Cited by:
  1. Basak, Suleyman & Makarov, Dmitry, 2012. "Difference in interim performance and risk taking with short-sale constraints," Journal of Financial Economics, Elsevier, vol. 103(2), pages 377-392.
  2. Basak, Suleyman & Makarov, Dmitry, 2011. "Strategic Asset Allocation in Money Management," CEPR Discussion Papers 8457, C.E.P.R. Discussion Papers.

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