Portfolio Performance Manipulation and Manipulation-Proof Performance Measures
Jonathan E. Ingersoll Jr.
Yale School of Management - International Center for Finance
Matthew I. Spiegel
Yale University - Yale School of Management, International Center for Finance
William N. Goetzmann
Yale School of Management - International Center for Finance; National Bureau of Economic Research (NBER)
UCLA; National Bureau of Economic Research (NBER)
The Review of Financial Studies, Vol. 20, Issue 5, pp. 1503-1546, 2007
Numerous measures have been proposed to gauge the performance of active management. Unfortunately, these measures can be gamed. Our article shows that gaming can have a substantial impact on popular measures even in the presence of high transactions costs. Our article shows there are conditions under which a manipulation-proof measure exists and fully characterizes it. This measure looks like the average of a power utility function, calculated over the return history. The case for using our alternative ranking metric is particularly compelling for hedge funds whose use of derivatives is unconstrained and whose managers' compensation itself induces a nonlinear payoff.
Keywords: G11, G23, G24
Date posted: June 26, 2008