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Relative Performance Evaluation Contracts and Asset Market Equilibrium

  • Sandeep Kapur

    (Birkbeck College, London)

  • Allan Timmermann

    (UCSD)

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 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 performance evaluation may lower the equity premium.

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File URL: http://econwpa.repec.org/eps/fin/papers/0408/0408005.pdf
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Paper provided by EconWPA in its series Finance with number 0408005.

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Length: 31 pages
Date of creation: 11 Aug 2004
Date of revision:
Handle: RePEc:wpa:wuwpfi:0408005
Note: Type of Document - pdf; pages: 31
Contact details of provider: Web page: http://econwpa.repec.org

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  4. Elroy Dimson & Paul Marsh & Mike Staunton, 2003. "Global Evidence On The Equity Risk Premium," Journal of Applied Corporate Finance, Morgan Stanley, vol. 15(4), pages 27-38.
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  8. Palomino, Frederic & Prat, Andrea, 2003. " Risk Taking and Optimal Contracts for Money Managers," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 113-37, Spring.
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  18. Mark Grinblatt & Sheridan Titman, 1989. "Adverse Risk Incentives and the Design of Performance-Based Contracts," Management Science, INFORMS, vol. 35(7), pages 807-822, July.
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