Munich Personal RePEc Archive

The effects of relative performance objectives on financial markets

Igan, Deniz and Pinheiro, Marcelo (2012): The effects of relative performance objectives on financial markets.

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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.

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