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Relative Performance Evaluation Contracts and Asset Market Equilibrium

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  • Sandeep Kapur

    (Department of Economics, Mathematics & Statistics, Birkbeck)

  • Allan Timmermann

Abstract

We analyse the equilibrium consequences of performance-based contracts for fund managers. Managerial remuneration is tied to a fund's absolute performance and its performance relative to rival funds. Investors choose whether or not to delegate their investment to better-informed fund managers; if they delegate they choose the parameters of the optimal contract subject to the fund manager's participation constraint. We find that the impact of relative performance evaluation on the equilibrium equity premium and on portfolio herding critically depends on whether the participation constraint is binding. Simple numerical examples suggest that the increased importance of delegation and relative performance evaluation may lower the equity premium.

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File URL: http://www.bbk.ac.uk/ems/research/wp/PDF/BWPEF0503.pdf
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Bibliographic Info

Paper provided by Birkbeck, Department of Economics, Mathematics & Statistics in its series Birkbeck Working Papers in Economics and Finance with number 0503.

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Date of creation: Jan 2005
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Handle: RePEc:bbk:bbkefp:0503

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Keywords: portfolio delegation; relative performance evaluation; equity premium;

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References

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Citations

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Cited by:
  1. Liu, Xiangbo & Qiu, Zhigang & Xiong, Yan, 2013. "VaR constrained asset pricing with relative performance," Economics Letters, Elsevier, vol. 121(2), pages 174-178.
  2. David Blake & Alberto G. Rossi & Allan Timmermann & Ian Tonks & Russ Wermers, 2013. "Decentralized Investment Management: Evidence from the Pension Fund Industry," Journal of Finance, American Finance Association, vol. 68(3), pages 1133-1178, 06.
  3. Opazo, Luis & Raddatz, Claudio & Schmukler, Sergio L., 2009. "The long and the short of emerging market debt," Policy Research Working Paper Series 5056, The World Bank.
  4. Jean-Daniel Guigou & Patrick De Lamirande & Bruno Lovat, 2011. "Strategic delegation and collusion: Do incentive schemes matter?," LSF Research Working Paper Series 11-02, Luxembourg School of Finance, University of Luxembourg.
  5. Gehrig, Thomas P. & Lütje, Torben & Menkhoff, Lukas, 2008. "Bonus Payments and Fund Managers' Behavior: Trans-Atlantic Evidence," Hannover Economic Papers (HEP) dp-411, Leibniz Universität Hannover, Wirtschaftswissenschaftliche Fakultät.
  6. Claudio Raddatz & Sergio Schmukler, 2013. "Deconstructing Herding: Evidence from Pension Fund Investment Behavior," Journal of Financial Services Research, Springer, vol. 43(1), pages 99-126, February.
  7. Huang, Shiyang & Qiu, Zhigang & Shang, Qi & Tang, Ke, 2013. "Asset pricing with heterogeneous beliefs and relative performance," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4107-4119.
  8. Opazo, Luis & Raddatz, Claudio & Schmukler, Sergio L., 2014. "Institutional investors and long-term investment : evidence from Chile," Policy Research Working Paper Series 6922, The World Bank.
  9. Cuoco, Domenico & Kaniel, Ron, 2009. "Equilibrium Prices in the Presence of Delegated Portfolio Management," CEPR Discussion Papers 7453, C.E.P.R. Discussion Papers.
  10. Premachandra, I.M. & Zhu, Joe & Watson, John & Galagedera, Don U.A., 2012. "Best-performing US mutual fund families from 1993 to 2008: Evidence from a novel two-stage DEA model for efficiency decomposition," Journal of Banking & Finance, Elsevier, vol. 36(12), pages 3302-3317.
  11. Cuoco, Domenico & Kaniel, Ron, 2011. "Equilibrium prices in the presence of delegated portfolio management," Journal of Financial Economics, Elsevier, vol. 101(2), pages 264-296, August.

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