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The effects of relative performance objectives on financial markets

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  • Igan, Deniz
  • Pinheiro, Marcelo

Abstract

We analyze the implications of linking the compensation of fund managers to the return of their portfolio relative to that of a benchmark. In the presence of such relative-performance-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 leads to increases in price volatility; (iii) home bias emerges as a rational outcome. Finally, when information is costly, information acquisition is hindered and this attenuates the effects on informativeness and depth of the market.

Suggested Citation

  • Igan, Deniz & Pinheiro, Marcelo, 2012. "The effects of relative performance objectives on financial markets," MPRA Paper 43452, University Library of Munich, Germany.
    • Handle: RePEc:pra:mprapa:43452
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    References listed on IDEAS

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    More about this item

    Keywords

    Delegated portfolio management; Informativeness; Liquidity; Contagion; Home bias;
    All these keywords.

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

    NEP fields

    This paper has been announced in the following NEP Reports:

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