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Strategic Asset Allocation in Money Management


  • Suleyman Basak

    () (London Business School and CEPR)

  • Dmitry Makarov

    () (New Economic School)


This article analyzes the dynamic portfolio choice implications of strategic interaction among money managers. The strategic interaction emerges as the managers compete for money flows displaying empirically documented convexities. A manager gets money flows increasing with performance, and hence displays relative performance concerns, if her relative return is above a threshold; otherwise she receives no (or constant) flows and has no relative concerns. We provide a tractable formulation of such strategic interaction between two risk averse managers in a continuous-time setting, and solve for their equilibrium policies in closed-form. When the managers’ risk aversions are considerably different, we do not obtain a Nash equilibrium as the managers cannot agree on who loses (getting no flows) in some states. We obtain equilibria, but multiple, when the managers are similar since they now care only about the total number of losing states. We recover a unique equilibrium, however, when a sufficiently high threshold makes the competition for money flows less intense. The managers’ unique equilibrium policies are driven by chasing and contrarian behaviors when either manager substantially outperforms the opponent, and by gambling behavior when their performances are close to the threshold. Depending on the stock correlation, the direction of gambling for a given manager may differ across stocks, however the two managers always gamble strategically in the opposite direction from each other in each individual stock.

Suggested Citation

  • Suleyman Basak & Dmitry Makarov, 2009. "Strategic Asset Allocation in Money Management," Working Papers w0158, Center for Economic and Financial Research (CEFIR).
  • Handle: RePEc:cfr:cefirw:w0158

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    Cited by:

    1. Axel Stahmer, 2015. "Fund flows inducing mispricing of risk in competitive financial markets," ESMT Research Working Papers ESMT-15-04, ESMT European School of Management and Technology.
    2. Basak, Suleyman & Makarov, Dmitry, 2012. "Difference in interim performance and risk taking with short-sale constraints," Journal of Financial Economics, Elsevier, vol. 103(2), pages 377-392.
    3. Ron Kaniel & Péter Kondor, 2013. "The Delegated Lucas Tree," Review of Financial Studies, Society for Financial Studies, vol. 26(4), pages 929-984.
    4. Fang, Dawei & Holmén, Martin & Kleinlercher, Daniel & Kirchler, Michael, 2017. "How tournament incentives affect asset markets: A comparison between winner-take-all tournaments and elimination contests," Journal of Economic Dynamics and Control, Elsevier, vol. 75(C), pages 1-27.
    5. Castañeda, Pablo & Devoto, Benjamín, 2016. "On the structural estimation of an optimal portfolio rule," Finance Research Letters, Elsevier, vol. 16(C), pages 290-300.
    6. Mark Whitmeyer, 2019. "Relative performance concerns among investment managers," Annals of Finance, Springer, vol. 15(2), pages 205-231, June.
    7. La Spada, Gabriele, 2018. "Competition, reach for yield, and money market funds," Journal of Financial Economics, Elsevier, vol. 129(1), pages 87-110.
    8. Mourad Mroua & Fathi Abid, 2014. "Portfolio revision and optimal diversification strategy choices," International Journal of Managerial Finance, Emerald Group Publishing, vol. 10(4), pages 537-564, August.
    9. Moreira, Alan, 2019. "Capital immobility and the reach for yield," Journal of Economic Theory, Elsevier, vol. 183(C), pages 907-951.
    10. Emmanuel Mamatzakis & Mike Tsionas, 2018. "A Bayesian dynamic model to test persistence in funds' performance," Working Paper series 18-23, Rimini Centre for Economic Analysis.
    11. Deng, Chao & Zeng, Xudong & Zhu, Huiming, 2018. "Non-zero-sum stochastic differential reinsurance and investment games with default risk," European Journal of Operational Research, Elsevier, vol. 264(3), pages 1144-1158.
    12. Asmussen, Søren & Christensen, Bent Jesper & Thøgersen, Julie, 2019. "Nash equilibrium premium strategies for push–pull competition in a frictional non-life insurance market," Insurance: Mathematics and Economics, Elsevier, vol. 87(C), pages 92-100.
    13. Suleyman Basak & Dmitry Makarov, 2013. "Competition among Portfolio Managers and Asset Specialization," Working Papers w0194, New Economic School (NES).
    14. Huang, Shiyang & Qiu, Zhigang & Shang, Qi & Tang, Ke, 2013. "Asset pricing with heterogeneous beliefs and relative performance," Journal of Banking & Finance, Elsevier, vol. 37(11), pages 4107-4119.
    15. Liu, Xiangbo & Qiu, Zhigang & Xiong, Yan, 2013. "VaR constrained asset pricing with relative performance," Economics Letters, Elsevier, vol. 121(2), pages 174-178.
    16. Han Feng & David Hobson, 2013. "Gambling in contests with regret," Papers 1301.0719,
    17. Zhu, Huainian & Cao, Ming & Zhang, Chengke, 2019. "Time-consistent investment and reinsurance strategies for mean-variance insurers with relative performance concerns under the Heston model," Finance Research Letters, Elsevier, vol. 30(C), pages 280-291.
    18. Goncalves-Pinto, Luis & Sotes-Paladino, Juan & Xu, Jing, 2018. "The invisible hand of internal markets in mutual fund families," Journal of Banking & Finance, Elsevier, vol. 89(C), pages 105-124.
    19. Chia-Ying Chan & Christine W. Lai & Liang-Chung Lee, 2017. "Strategic Choice of Risk: Evidence from Mutual Fund Families," Journal of Financial Services Research, Springer;Western Finance Association, vol. 51(1), pages 125-163, February.
    20. Alain Bensoussan & Abel Cadenillas & Hyeng Keun Koo, 2015. "Entrepreneurial Decisions on Effort and Project with a Nonconcave Objective Function," Mathematics of Operations Research, INFORMS, vol. 40(4), pages 902-914, October.
    21. Guan, Guohui & Liang, Zongxia, 2016. "A stochastic Nash equilibrium portfolio game between two DC pension funds," Insurance: Mathematics and Economics, Elsevier, vol. 70(C), pages 237-244.
    22. Castaneda, Pablo & Rudolph, Heinz P., 2011. "Upgrading investment regulations in second pillar pension systems : a proposal for Colombia," Policy Research Working Paper Series 5775, The World Bank.

    More about this item


    Money Managers; Strategic Interaction; Portfolio Choice; Relative Performance; Incentives; Risk Shifting; Fund Flows; Tournaments;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G20 - Financial Economics - - Financial Institutions and Services - - - General
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • C73 - Mathematical and Quantitative Methods - - Game Theory and Bargaining Theory - - - Stochastic and Dynamic Games; Evolutionary Games
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis


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