The effects of relative performance objectives on financial markets

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

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.

• Item Type: MPRA Paper
• Language: English
• Keywords: Delegated portfolio management, Informativeness, Liquidity, Contagion, Home bias
• Subjects: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G2 - Financial Institutions and Services > G23 - Non-bank Financial Institutions ; Financial Instruments ; Institutional Investors

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