Performance Evaluation in Competitive REE Models

51 Pages Posted: 17 Oct 2010 Last revised: 17 Mar 2012

See all articles by Paolo Colla

Paolo Colla

Bocconi University - Department of Finance; Bocconi University - BAFFI Center on International Markets, Money, and Regulation

Jose M. Marin

Charles III University of Madrid

Date Written: October 15, 2010

Abstract

Our basic premise is that fund managers performance is related to superior information about an asset payoff. We investigate the relationship between managerial skills and trading behavior within a two-period rational expectation equilibrium (REE) model where agents trade on private information in the first round, while a public signal arrives at the second date that makes traders revise their beliefs and retrade. The public signal can be related to the asset payoff, or to variables not related to fundamentals (noise), or both. We characterize the unique partially revealing REE and explore the drivers of price dynamics and trading behavior. Our main prediction is that good managers are contrarian traders, while bad managers are momentum traders when public news arrive to the market. Furthermore, the change in holdings of each type of trader is monotonic on the traders' skills. Based on these predictions, we propose new performance evaluation measures that rely on the manager's change in holdings around the arrival of public news rather than his past performance. A byproduct of our analysis is the proposal of a new protocol for performance evaluation and Due Diligence (DD) procedures.

Keywords: REE, Performance Evaluation, Mutual Funds, Hedge Funds, Talent, Informed Traders, Due Diligence

JEL Classification: G11, G12, G14

Suggested Citation

Colla, Paolo and Marin, Jose M., Performance Evaluation in Competitive REE Models (October 15, 2010). Available at SSRN: https://ssrn.com/abstract=1693216 or http://dx.doi.org/10.2139/ssrn.1693216

Paolo Colla (Contact Author)

Bocconi University - Department of Finance ( email )

Via Roentgen 1
Milano, MI 20136
Italy

Bocconi University - BAFFI Center on International Markets, Money, and Regulation ( email )

Milano, 20136
Italy

Jose M. Marin

Charles III University of Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain

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

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