Risk Management with Benchmarking

Teplá, Lucie, Suleyman Basak and Alex Shapiro

No 5187, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: Portfolio theory must address the fact that, in reality, portfolio managers are evaluated relative to a benchmark, and therefore adopt risk management practices to account for the benchmark performance. We capture this risk management consideration by allowing a prespecified shortfall from a target benchmark-linked return, consistent with growing interest in such practice. In a dynamic setting, we demonstrate how a risk averse portfolio manager optimally under- or overperforms a target benchmark under different economic conditions, depending on his attitude towards risk and choice of the benchmark. The analysis therefore illustrates how investors can achieve their desired performance profile for funds under management through an appropriate combined choice of the benchmark and money manager. We consider a variety of extensions, and also highlight the ability of our setting to shed some light on documented return patterns across segments of the money management industry.

Keywords: Benchmarking; Investments; Shortfall risk; Tracking error; Value-at-risk (search for similar items in EconPapers)
JEL-codes: D81 G11 G23 (search for similar items in EconPapers)
Date: 2005-08
New Economics Papers: this item is included in nep-bec, nep-fin, nep-fmk and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (12)

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Journal Article: Risk Management with Benchmarking (2006)
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