Managerial incentives and financial contagion

Sujit Chakravorti, Anna Ilyina and Subir Lall

No WP-03-21, Working Paper Series from Federal Reserve Bank of Chicago

Abstract: This paper proposes a framework to examine the comovements of asset prices with seemingly unrelated fundamentals, as an outcome of the optimal portfolio strategies of large institutional fund managers. In emerging markets, the dominant presence of dedicated fund managers whose compensation is linked to the outperformance of their portfolio relative to a benchmark index, and of global fund managers whose compensation is linked to the absolute returns of their portfolios, leads to portfolio decisions that result in systematic interactions between asset prices even in the absence of asymmetric information. The model endogenously determines the optimal amount of cash holdings or leverage, the incidence of relative value versus macro hedge fund strategies, and how prices can systematically deviate from the long-term fundamental value for long periods of time, with limits to the arbitrage of this differential. Managerial compensation contracts, while optimal at a firm level, may lead to inefficiencies at the macroeconomic level. We identify conditions when a negative shock to one emerging market affects another market negatively.

Keywords: Financial crises; Mutual funds (search for similar items in EconPapers)
Date: 2003
New Economics Papers: this item is included in nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

Downloads: (external link)
http://www.chicagofed.org/digital_assets/publicati ... s/2003/wp2003-21.pdf (application/pdf)

Related works:
Working Paper: Managerial Incentives and Financial Contagion (2004)
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:fip:fedhwp:wp-03-21

Ordering information: This working paper can be ordered from

Access Statistics for this paper

More papers in Working Paper Series from Federal Reserve Bank of Chicago Contact information at EDIRC.
Bibliographic data for series maintained by Lauren Wiese ().