Herding in Delegated Portfolio Management: When is Comparative Performance Information Desirable?

Posted: 17 Nov 2003

See all articles by Alexander Guembel

Alexander Guembel

Toulouse School of Economics, University of Toulouse Capitole; Toulouse School of Management

Abstract

We address the issue of investors' asset allocation decisions when portfolio management is delegated to an agent. Contrary to predictions from traditional financial theory, it is shown that investors may not induce their manager to allocate funds to the asset with the highest return. Instead they may herd in their asset allocation decision and induce trade in a particular asset, because another manager is trading in it and despite the presence of a more profitable alternative. Doing so allows investors to write an efficiency-improving relative-performance contract. On the other hand, herding leads investors to design wage contracts strategically, resulting in more aggressive and thus less profitable trade in equilibrium. We show that herding occurs when the cost of information is high, information precision is low and when managers are sufficiently risk averse. Moreover, when investors can decide whether or not to disclose information about their manager's performance, they will not do so.

JEL Classification: G14, G23, D82

Suggested Citation

Guembel, Alexander, Herding in Delegated Portfolio Management: When is Comparative Performance Information Desirable?. Available at SSRN: https://ssrn.com/abstract=460202

Alexander Guembel (Contact Author)

Toulouse School of Economics, University of Toulouse Capitole ( email )

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Toulouse School of Management

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France

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