Relative Performance Equilibrium in Financial Markets

Frederic Palomino

No 1993, CEPR Discussion Papers from C.E.P.R. Discussion Papers

Abstract: Money management is an activity in which agents are often evaluated on the basis of their relative performance. In this article we consider an oligopolistic market in which some informed fund managers aim at maximizing their relative performance, rather than their absolute performance. First, we define a Relative Performance Equilibrium and derive conditions for the existence of such an equilibrium. Secondly, we analyse equilibrium trading strategies. We show that the relative performance evaluation provides incentives to play overly risky strategies, i.e. in equilibrium, and fund managers choose riskier portfolios than they would do if they were maximizing their absolute performance. One of the positive consequences is a higher level of informational efficiency.

Keywords: absolute performance; overly-risky strategy; relative performance (search for similar items in EconPapers)
JEL-codes: G14 G20 (search for similar items in EconPapers)
Date: 1998-10
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