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Relative Performance Equilibrium in Financial Markets

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  • Palomino, Frédéric

Abstract

Money management is an activity in which agents are often evaluated on the basis of their relative performance. In this article we consider an oligopolistic market in which some informed fund managers aim at maximizing their relative performance, rather than their absolute performance. First, we define a Relative Performance Equilibrium and derive conditions for the existence of such an equilibrium. Secondly, we analyse equilibrium trading strategies. We show that the relative performance evaluation provides incentives to play overly risky strategies, i.e. in equilibrium, and fund managers choose riskier portfolios than they would do if they were maximizing their absolute performance. One of the positive consequences is a higher level of informational efficiency.

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Paper provided by C.E.P.R. Discussion Papers in its series CEPR Discussion Papers with number 1993.

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Date of creation: Oct 1998
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Handle: RePEc:cpr:ceprdp:1993

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Keywords: absolute performance; overly-risky strategy; relative performance;

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  1. De Long, J Bradford & Andrei Shleifer & Lawrence H. Summers & Robert J. Waldmann, 1990. "Noise Trader Risk in Financial Markets," Journal of Political Economy, University of Chicago Press, vol. 98(4), pages 703-38, August.
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Cited by:
  1. Alexander Guembel, 2001. "Emerging Markets and Entry by Actively Managed Funds," Economics Series Working Papers 2001-FE-12, University of Oxford, Department of Economics.
  2. Palomino, F.A. & Prat, A., 1998. "Dynamic Incentives in the Money Management Tournament," Discussion Paper 1998-107, Tilburg University, Center for Economic Research.

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