Mutual-Fund Benchmarking and Market Bubbles: A Behavioral Approach Alberto Bertoni 1 , Giorgio Bertinetti 2 , and Chiara Cesari 3 1 Centro di Ricerche Economico-Aziendali e sull’Imprenditorialità, Bocconi University, Milan, Italy 2 Dipartimento di Economia e Direzione Aziendale, University Ca’ Foscari, Venice, Italy 3 Bocconi University, Milan, Italy (E-mail: Alberto.Bertoni@uni-bocconi.it, Bertinet@unive.it) Abstract. Dynamics of equity risk premium is not directly measurable on the market. Numerous studies and empirical research analyse its volatility also considering the time span, concluding that the dynamics of equity risk premium over time is inversely proportional to the economic cycle. This study analyses the passive role that, implicitly, would place institutional investors in such a context. In reality, savings management is delegated to a small number of professional operators (institutional investors), as opposed to pure theoretical models in which every person can act directly on the market thus ensuring unlimited price elasticity. Institutional investors should be ra- tional and completely informed so that they can assume an anticyclical position on the market. Thus, supply and demand should quickly smooth over emerging price pres- sures and avoid price bubbles. We analyse one possible explanation for this situation not to occur, namely, that professionals suffer from operational limits that prevent them from doing their job in the best possible way. Using empirical evidence from the Italian Stock Exchange (Comit Index), we conclude that three factors reduce the freedom of institutional investors to manage their portfolios  the market target size, the fund structure, and the benchmarking  and discuss some implications for each of them. Keywords equity risk premium, institutional investors, mutual funds, market bub- bles, benchmarking The equity risk premium is not directly measurable on the market. For this reason, it is necessary to provide an estimate, and many studies all over the world have worked towards this goal. It is not easy to achieve, and the existence of numerous theoretical models (none of which excels over the others) proves this (Mehra and Prescott 1985). Transition Studies Review (2005) 12 (1): 3643 DOI 10.1007/s11300-005-0033-4 Transition Studies Review Ó Springer-Verlag 2005 Printed in Austria