Risk Taking and Optimal Contracts for Money Managers
AbstractWe study delegated portfolio management when the agent controls the riskiness of the portfolio. Under general conditions, we show that the optimal contract is simply a bonus contract: the agent is paid a fixed sum if the portfolio return is above a threshold. We derive a criterion to decide whether the optimal contract induces excessive or insufficient risk. If a deviation from efficient risk taking causes a large (small) reduction in the expected return of the portfolio, the optimal contract induces excessive (insufficient) risk. In other words, the cheaper it is to play with risk, the less risk the agent takes. Copyright 2003 by the RAND Corporation.
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Bibliographic InfoArticle provided by The RAND Corporation in its journal RAND Journal of Economics.
Volume (Year): 34 (2003)
Issue (Month): 1 (Spring)
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Other versions of this item:
- Palomino, F. & Prat, A., 1998. "Risk taking and optimal contracts for money managers," Discussion Paper 1998-108, Tilburg University, Center for Economic Research.
- Palomino, Frédéric & Prat, Andrea, 1999. "Risk Taking and Optimal Contracts for Money Managers," CEPR Discussion Papers 2066, C.E.P.R. Discussion Papers.
- D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
- G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
- G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
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