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The impact of benchmarking and portfolio constraints on a fund manager´s market timing ability

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Author Info
JUAN PEDRO GOMEZ () (Instituto de Empresa)
Abstract

We study the effects that relative (to a benchmark) performance evaluation has on the provision of incentives for the search of private information when managers are exogenously constrained in their ability to sell short and purchase on margin. With these portfolio constraints we show that benchmarking the manager´s incentive fee affect her timing ability and hence there exist an optimal benchmark, even without moral hazard between the investor and manager. In the presence of moral hazard, numerical results show that the optimal incentive fee is higher than the Pareto-efficient fee and the optimal benchmark is risky but less so than the no moral hazard benchmark.

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Paper provided by Instituto de Empresa, Area of Economic Environment in its series Working Papers Economia with number wp07-02.

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Length: 32 pages
Date of creation: Mar 2007
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Handle: RePEc:emp:wpaper:wp07-02

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Keywords: Benchmarking Incentive fee Market timing Portfolio constraints

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  1. Becker, Connie & Ferson, Wayne & Myers, David H. & Schill, Michael J., 1999. "Conditional market timing with benchmark investors," Journal of Financial Economics, Elsevier, vol. 52(1), pages 119-148, April. [Downloadable!] (restricted)
  2. Bhattacharya, Sudipto & Pfleiderer, Paul, 1985. "Delegated portfolio management," Journal of Economic Theory, Elsevier, vol. 36(1), pages 1-25, June. [Downloadable!] (restricted)
  3. Hui Ou-Yang, 2003. "Optimal Contracts in a Continuous-Time Delegated Portfolio Management Problem," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 16(1), pages 173-208.
  4. Almazan, Andres & Brown, Keith C. & Carlson, Murray & Chapman, David A., 2004. "Why constrain your mutual fund manager?," Journal of Financial Economics, Elsevier, vol. 73(2), pages 289-321, August. [Downloadable!] (restricted)
  5. 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. [Downloadable!] (restricted)
  6. Juan-Pedro Gómez & Tridib Sharma, 2006. "Portfolio delegation under short-selling constraints," Economic Theory, Springer, vol. 28(1), pages 173-196, 05. [Downloadable!] (restricted)
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  7. Merton, Robert C, 1981. "On Market Timing and Investment Performance. I. An Equilibrium Theory of Value for Market Forecasts," Journal of Business, University of Chicago Press, vol. 54(3), pages 363-406, July. [Downloadable!] (restricted)
  8. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
    Other versions:
  9. Diane Del Guercio & Paula A. Tkac, 2000. "The determinants of the flow of funds of managed portfolios: mutual funds versus pension funds," Working Paper 2000-21, Federal Reserve Bank of Atlanta. [Downloadable!]
  10. Juan-Pedro Gómez & Fernando Zapatero, 2003. "Asset pricing implications of benchmarking: a two-factor CAPM," European Journal of Finance, Taylor and Francis Journals, vol. 9(4), pages 343-357, August. [Downloadable!] (restricted)
  11. Michael Brennan, 1993. "Agency and Asset Pricing," University of California at Los Angeles, Anderson Graduate School of Management 1147, Anderson Graduate School of Management, UCLA. [Downloadable!]
  12. 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. [Downloadable!] (restricted)
  13. Edwin J. Elton & Martin J. Gruber & Christopher R. Blake, 2003. "Incentive Fees and Mutual Funds," Journal of Finance, American Finance Association, vol. 58(2), pages 779-804, 04. [Downloadable!] (restricted)
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