Portfolio Delegation and Market Efficiency

63 Pages Posted: 20 Feb 2014

See all articles by Semyon Malamud

Semyon Malamud

Ecole Polytechnique Federale de Lausanne; Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Evgeny Petrov

HKUST

Date Written: February 20, 2014

Abstract

We develop a two-period general equilibrium model of portfolio delegation with competitive, differentially skilled managers and convex compensation contracts. We show that convex incentives lead to significant equilibrium mispricing, but reduce price volatility. In particular, price informativeness and volatility may exhibit opposite behaviour. Investors do not internalize the externality that their contract choice has on equilibrium prices. As a result, equilibrium incentives may be too strong or too weak and hurt investors as a whole. For example, investors' utility may be decreasing in the average managers' skill. Convex incentives amplify this negative externality. Indirect incentives due to future fund flows may induce investors to choose stronger convex direct incentives, amplifying inefficiencies even further. Inference of skill from performance is asymmetric: past bad performance is indicative of low skill, but past good performance is not indicative of high skill.

Keywords: portfolio delegation, optimal incentives, contracts, asymmetric information, informational efficiency

JEL Classification: G14, D86, G23, D53

Suggested Citation

Malamud, Semyon and Petrov, Evgeny, Portfolio Delegation and Market Efficiency (February 20, 2014). Swiss Finance Institute Research Paper No. 14-09, Available at SSRN: https://ssrn.com/abstract=2397891 or http://dx.doi.org/10.2139/ssrn.2397891

Semyon Malamud (Contact Author)

Ecole Polytechnique Federale de Lausanne ( email )

Lausanne, 1015
Switzerland

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

Swiss Finance Institute

c/o University of Geneva
40, Bd du Pont-d'Arve
CH-1211 Geneva 4
Switzerland

Evgeny Petrov

HKUST ( email )

Clear Water Bay
Kowloon
Hong Kong

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