An Institutional REE Model with Relative Performance

Abstract

This paper studies a noisy rational expectation equilibrium (REE) model of the delegated portfolio management in which fund managers care about the relative performance. We show that, with the relative performance, both informed and uninformed managers need to hedge. The informed hedge the uncertainty from other informed signals, and try to learn those signals if they are correlated. The informed hedging behavior changes the weight they put on the private signals. In contrast, the uninformed hedging changes the trading aggressiveness. By isolating the the informed and uninformed hedging, we study the models with asymmetric information and dierential information respectively. The information transmitting process with relative performance is studied under the asymmetric information model in which the uninformed hedging has a result of over-trading. Although the informed do not need to hedge in this case, they disclose less information than they would do without relative performance. As a result, the information content in the equilibrium price relative to the noise is lower. The information aggregation process is studied under the dierential information model in which all the managers are equally informed with independent signals. This model studies the eect of the informed hedging to the information aggregation, and we show that it depends on how much information managers can get from their private information. Finally, by introducing an additional public signal to the dierential information model, we show managers put less weight on private signals than the public one.