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Relative Performance, Risk and Entry in the Mutual Fund Industry

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  • Loranth Gyongyi

    ()
    (Judge Business School, University of Cambridge)

  • Sciubba Emanuela

    ()
    (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): 6 (2006)
Issue (Month): 1 (September)
Pages: 1-28

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

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  1. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  2. Goriaev, Alexei & Nijman, Theo E. & Werker, Bas J. M., 2005. "Yet another look at mutual fund tournaments," Journal of Empirical Finance, Elsevier, vol. 12(1), pages 127-137, January.
  3. 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.
  4. Ahmed, Parvez, 2001. "Forecasting correlation among equity mutual funds," Journal of Banking & Finance, Elsevier, vol. 25(6), pages 1187-1208, June.
  5. Emanuela Sciubba, 2000. "Relative Performance and Herding in Financial Markets," Econometric Society World Congress 2000 Contributed Papers 1570, Econometric Society.
  6. 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.
  7. Hans K. Hvide, 2000. "Tournament Rewards and Risk Taking," Econometric Society World Congress 2000 Contributed Papers 0163, Econometric Society.
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  9. Bengt Holmstrom, 1981. "Moral Hazard in Teams," Discussion Papers 471, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
  10. Palomino, Frederic, 2005. "Relative performance objectives in financial markets," Journal of Financial Intermediation, Elsevier, vol. 14(3), pages 351-375, July.
  11. Mookherjee, Dilip, 1984. "Optimal Incentive Schemes with Many Agents," Review of Economic Studies, Wiley Blackwell, vol. 51(3), pages 433-46, July.
  12. Goriaev, A.P. & Palomino, F.A. & Prat, A., 2000. "Mutual Fund Tournament: Risk Taking Incentives Induced by Ranking Objectives," Discussion Paper 2000-94, Tilburg University, Center for Economic Research.
  13. 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.
  14. 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.
  15. Taylor, Jonathan, 2003. "Risk-taking behavior in mutual fund tournaments," Journal of Economic Behavior & Organization, Elsevier, vol. 50(3), pages 373-383, March.
  16. 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.
  17. 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.
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Cited by:
  1. Basak, Suleyman & Makarov, Dmitry, 2010. "Difference in Interim Performance and Risk Taking with Short-Sale Constraints," CEPR Discussion Papers 8072, C.E.P.R. Discussion Papers.
  2. Suleyman Basak & Dmitry Makarov, 2009. "Strategic Asset Allocation in Money Management," Working Papers w0158, Center for Economic and Financial Research (CEFIR).
  3. Suleyman Basak & Dmitry Makarov, 2013. "Competition among Portfolio Managers and Asset Specialization," Working Papers w0194, Center for Economic and Financial Research (CEFIR).

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