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Performance evaluation in competitive REE models

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  • Paolo Colla

    () (Università Bocconi)

  • José M. Marín

    () (IMDEA Social Sciences Institute)

Abstract

Our basic premise is that fund managers performance is related to superior information about an asset payoff. We investigate the relationship between managerial skills and trading behavior within a two-period rational expectation equilibrium (REE) model where agents trade on private information in the first round, while a public signal arrives at the second date that makes traders revise their beliefs and retrade. The public signal can be related to the asset payoff, or to variables not related to fundamentals (noise), or both. We characterize the unique partially revealing REE and explore the drivers of price dynamics and trading behavior. Our main prediction is that good managers are contrarian traders, while bad managers are momentum traders when public news arrive to the market. Furthermore, the change in holdings of each type of trader is monotonic on the traders' skills. Based on these predictions, we propose new performance evaluation measures that rely on the manager's change in holdings around the arrival of public news rather than his past performance. A byproduct of our analysis is the proposal of a new protocol for performance evaluation and Due Diligence (DD) procedures.

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Bibliographic Info

Paper provided by Instituto Madrileño de Estudios Avanzados (IMDEA) Ciencias Sociales in its series Working Papers with number 2010-21.

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Date of creation: 18 Oct 2010
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Handle: RePEc:imd:wpaper:wp2010-21

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Keywords: REE; performance evaluation; mutual fund; hedge funds; talent; informed traders; due diligence;

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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. Marin, Jose M & Rahi, Rohit, 2000. "Information Revelation and Market Incompleteness," Review of Economic Studies, Wiley Blackwell, vol. 67(3), pages 563-79, July.
  3. Marcin Kacperczyk & Amit Seru, 2007. "Fund Manager Use of Public Information: New Evidence on Managerial Skills," Journal of Finance, American Finance Association, vol. 62(2), pages 485-528, 04.
  4. Péter Kondor, 2009. "The more we know, the less we agree: Higher-order expectations and public announcements," 2009 Meeting Papers 1018, Society for Economic Dynamics.
  5. Jackwerth, Jens Carsten, 2000. "Recovering Risk Aversion from Option Prices and Realized Returns," Review of Financial Studies, Society for Financial Studies, vol. 13(2), pages 433-51.
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