Portfolio Delegation and Market Efficiency

Semyon Malamud and Evgeny Petrov
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Semyon Malamud: Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute
Evgeny Petrov: Ecole Polytechnique Fédérale de Lausanne and Swiss Finance Institute (PhD Program)

No 14-09, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

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.

Keywords: portfolio delegation; optimal incentives; contracts; asymmetric information; informational efficiency (search for similar items in EconPapers)
JEL-codes: D53 D86 G14 G23 (search for similar items in EconPapers)
Pages: 63 pages
Date: 2014-02
New Economics Papers: this item is included in nep-upt
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Citations: View citations in EconPapers (11)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp1409

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