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Portfolio delegation under short-selling constraints

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  • Juan-Pedro Gómez
  • Tridib Sharma

Abstract

In this paper we study delegated portfolio management when the manager's ability to short-sell is restricted. Contrary to previous results, we show that under moral hazard, linear performance-adjusted contracts do provide portfolio managers with incentives to gather information. The risk-averse manager's optimal effort is an increasing function of her share in the portfolio's return. This result affects the risk-averse investor's optimal contract decision. The first best, purely risk-sharing contract is proved to be suboptimal. Using numerical methods we show that the manager's share in the portfolio return is higher than the „rst best share. Additionally, this deviation is shown to be: (i) increasing in the manager's risk aversion and (ii) larger for tighter short-selling restrictions. When the constraint is relaxed the optimal contract converges towards the first best risk sharing contract.

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Bibliographic Info

Paper provided by Department of Economics and Business, Universitat Pompeu Fabra in its series Economics Working Papers with number 695.

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Date of creation: Jun 2003
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Handle: RePEc:upf:upfgen:695

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Web page: http://www.econ.upf.edu/

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Keywords: Third best effort; linear performance-adjusted contracts; short-selling constraints;

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Cited by:
  1. Alexander, Gordon J. & Baptista, Alexandre M., 2011. "Portfolio selection with mental accounts and delegation," Journal of Banking & Finance, Elsevier, Elsevier, vol. 35(10), pages 2637-2656, October.
  2. Sheng, Jiliang & Wang, Xiaoting & Yang, Jun, 2012. "Incentive contracts in delegated portfolio management under VaR constraint," Economic Modelling, Elsevier, Elsevier, vol. 29(5), pages 1679-1685.
  3. Wang, Jian & Sheng, Jiliang & Yang, Jun, 2013. "Optimism bias and incentive contracts in portfolio delegation," Economic Modelling, Elsevier, Elsevier, vol. 33(C), pages 493-499.
  4. Basak, Suleyman & Pavlova, Anna & Shapiro, Alexander, 2008. "Offsetting the implicit incentives: Benefits of benchmarking in money management," Journal of Banking & Finance, Elsevier, Elsevier, vol. 32(9), pages 1883-1893, September.
  5. Agarwal, Vikas & Gómez, Juan-Pedro & Priestley, Richard, 2011. "Management compensation and market timing under portfolio constraints," CFR Working Papers 11-16, University of Cologne, Centre for Financial Research (CFR).
  6. Sheng, Jiliang & Wang, Jian & Wang, Xiaoting & Yang, Jun, 2014. "Asymmetric contracts, cash flows and risk taking of mutual funds," Economic Modelling, Elsevier, Elsevier, vol. 38(C), pages 435-442.

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