Jules H. van Binsbergen Michael W. Brandt Ralph S.J. Koijen
Abstract
We study a decentralized investment problem in which a CIO employs multiple asset managers to implement and execute investment strategies in separate asset classes. The CIO allocates capital to the managers who, in turn, allocate these funds to the assets in their asset class. This two-step investment process causes several misalignments of objectives between the CIO and his managers and can lead to large utility costs on the part of the CIO. We focus on i) loss of diversification ii) different appetites for risk, iii) different investment horizons, and iv) the presence of liabilities. We derive an optimal unconditional linear performance benchmark and show that this benchmark can be used to better align incentives within the firm. The optimal benchmark substantially mitigates the utility costs of decentralized investment management. These costs can be further reduced when the CIO can screen asset managers on the basis of their risk appetites. Each manager%u2019s optimal level of risk aversion depends on the asset class he manages and can differ substantially from the CIO%u2019s level of risk aversion.
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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number
12144.
Length: Date of creation: Apr 2006 Date of revision: Handle: RePEc:nbr:nberwo:12144
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Find related papers by JEL classification: G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data) G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
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