Description

We analyze the implications of linking the compensation of fund managers to the return
of their portfolio relative to that of a benchmark—a common solution to the agency
problem in delegated portfolio management. In the presence of such relativeperformance-
based objectives, investors have reduced expected utility but markets are
typically more informative and deeper. Furthermore, in a multiple asset/market
framework we show that (i) relative performance concerns lead to an increase in the
correlation between markets (financial contagion); (ii) benchmark inclusion increases
price volatility; (iii) home bias emerges as a rational outcome. When information is
costly, information acquisition is hindered and this attenuates the effects on
informativeness and depth of the market.

More publications in this series: Working Papers

More publications by: Deniz Igan ; Marcelo Pinheiro