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Portfolio Delegation and Market Efficiency

Author

Listed:
  • Semyon MALAMUD

    (Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute)

  • Evgeny PETROV

    (Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute (PhD Program))

Abstract

We develop a two-period general equilibrium model of portfolio delegation with competitive, differentially skilled managers and convex compensation contracts. We show that convex incentives lead to significant equilibrium mispricing, but reduce price volatility. In particular, price informativeness and volatility may exhibit opposite behaviour. Investors do not internalize the externality that their contract choice has on equilibrium prices. As a result, equilibrium incentives may be too strong or too weak and hurt investors as a whole. For example, investors' utility may be decreasing in the average managers' skill. Convex incentives amplify this negative externality. Indirect incentives due to future fund flows may induce investors to choose stronger convex direct incentives, amplifying inefficiencies even further. Inference of skill from performance is asymmetric: past bad performance is indicative of low skill, but past good performance is not indicative of high skill.

Suggested Citation

  • Semyon MALAMUD & Evgeny PETROV, 2014. "Portfolio Delegation and Market Efficiency," Swiss Finance Institute Research Paper Series 14-09, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1409
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    File URL: http://ssrn.com/abstract=2397891
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    Cited by:

    1. Lagziel, David & Lehrer, Ehud, 2018. "Reward schemes," Games and Economic Behavior, Elsevier, vol. 107(C), pages 21-40.
    2. Cvitanić, Jakša & Xing, Hao, 2018. "Asset pricing under optimal contracts," Journal of Economic Theory, Elsevier, vol. 173(C), pages 142-180.
    3. Andrea M. Buffa & Dimitri Vayanos & Paul Woolley, 2022. "Asset Management Contracts and Equilibrium Prices," Journal of Political Economy, University of Chicago Press, vol. 130(12), pages 3146-3201.
    4. Zeno Enders & Hendrik Hakenes, 2021. "Market Depth, Leverage, and Speculative Bubbles," Journal of the European Economic Association, European Economic Association, vol. 19(5), pages 2577-2621.
    5. David Lagziel & Ehud Lehrer, 2021. "Transferable deposits as a screening mechanism," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 71(2), pages 483-504, March.
    6. Annalisa Fabretti & Tommy Gärling & Stefano Herzel & Martin Holmen, 2017. "Convex incentives in financial markets: an agent-based analysis," Decisions in Economics and Finance, Springer;Associazione per la Matematica, vol. 40(1), pages 375-395, November.
    7. Matthijs Breugem & Adrian Buss, 2017. "Institutional Investors and Information Acquisition: Implications for Asset Prices and Informational Efficiency," Carlo Alberto Notebooks 524, Collegio Carlo Alberto.

    More about this item

    Keywords

    portfolio delegation; optimal incentives; contracts; asymmetric information; informational efficiency;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • D53 - Microeconomics - - General Equilibrium and Disequilibrium - - - Financial Markets

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