Offsetting the Implicit Incentives: Benefits of Benchmarking in Money Management

24 Pages Posted: 18 Aug 2006 Last revised: 17 Dec 2007

See all articles by Suleyman Basak

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Alex Shapiro

New York University (NYU) - Department of Finance

Date Written: November 2007

Abstract

Money managers are rewarded for increasing the value of assets under management. This gives a manager an implicit incentive to exploit the well-documented positive fund-flows to relative-performance relationship by manipulating her risk exposure. The misaligned incentives create potentially significant deviations of the manager's policy from that desired by fund investors. In the context of a familiar continuous-time portfolio choice model, we demonstrate how a simple risk management practice that accounts for benchmarking can ameliorate the adverse effects of managerial incentives. Our results contrast with the conventional view that benchmarking a fund manager is not in the best interest of investors.

Keywords: Benchmarking, Fund Flows, Implicit Incentives, Risk Taking, Risk Management, Portfolio Choice

JEL Classification: G11, G20, D60, D81

Suggested Citation

Basak, Suleyman and Pavlova, Anna and Shapiro, Alex, Offsetting the Implicit Incentives: Benefits of Benchmarking in Money Management (November 2007). Available at SSRN: https://ssrn.com/abstract=924768 or http://dx.doi.org/10.2139/ssrn.924768

Suleyman Basak (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)

HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Anna Pavlova

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7000 8218 (Phone)

HOME PAGE: http://faculty.london.edu/apavlova

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Alex Shapiro

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0362 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~ashapiro/

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