Risk Management with Benchmarking
London Business School; Centre for Economic Policy Research (CEPR)
New York University (NYU) - Department of Finance
NYU Working Paper No. S-CDM-01-04
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. Investors can therefore achieve their desired gain/loss characteristics for funds under management through an appropriate combined choice of the benchmark and money manager.
Number of Pages in PDF File: 38
Keywords: Benchmarking, Investments, shortfall Risk, Tracking Error, value-at-riskworking papers series
Date posted: November 5, 2008
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