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Relative Performance Evaluation Contracts and Asset Market Equilibrium

  • Sandeep Kapur

    (Department of Economics, Mathematics & Statistics, Birkbeck)

  • Allan Timmermann

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
File Function: First version, 2005
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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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