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The delegated Lucas tree

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  • Kaniel, Ron
  • Kondor, Péter

Abstract

We analyze the effects of the observed increased share of delegated capital for trading strategies and equilibrium prices by introducing delegation into a standard Lucas exchange economy. In equilibrium, some investors trade on their own account, but others decide to delegate trading to professional fund managers. Flow performance incentive functions describe how much capital clients provide to funds at each date as a function of past performance. Convex flow-performance relations imply that the average fund outperforms the market in recessions and underperforms in expansions. When the share of capital that is delegated is low, all funds follow the same strategy. However, when the equilibrium share of delegated capital is high, funds with identical incentives employ heterogeneous trading strategies. A group of managers borrows to take on a levered position on the stock. Thus, fund returns are dispersed in the cross-section and the outstanding amounts of borrowing and lending increase. The relation between the share of delegated capital and the Sharpe ratio typically follows an inverse U-shape pattern.

Suggested Citation

  • Kaniel, Ron & Kondor, Péter, 2011. "The delegated Lucas tree," CEPR Discussion Papers 8578, C.E.P.R. Discussion Papers.
  • Handle: RePEc:cpr:ceprdp:8578
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    References listed on IDEAS

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    Cited by:

    1. repec:eee:jfinec:v:112:y:2014:i:2:p:213-231 is not listed on IDEAS
    2. Nicola Gennaioli & Andrei Shleifer & Robert Vishny, 2015. "Money Doctors," Journal of Finance, American Finance Association, vol. 70(1), pages 91-114, February.
    3. repec:eee:jetheo:v:173:y:2018:i:c:p:142-180 is not listed on IDEAS
    4. Mehmet Balcilar & Riza Demirer & Rangan Gupta & Mark E. Wohar, 2018. "Differences of opinion and stock market volatility: evidence from a nonparametric causality-in-quantiles approach," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 42(2), pages 339-351, April.
    5. Idan Hodor & Andrea Buffa, 2017. "Institutional Investors, Heterogeneous Benchmarks and the Comovement of Asset Prices," 2017 Meeting Papers 374, Society for Economic Dynamics.
    6. Sato, Yuki, 2016. "Delegated portfolio management, optimal fee contracts, and asset prices," Journal of Economic Theory, Elsevier, vol. 165(C), pages 360-389.
    7. Johnson, Timothy C., 2016. "Rethinking reversals," Journal of Financial Economics, Elsevier, vol. 120(2), pages 211-228.
    8. Sheng, Jiliang & Wang, Jian & Wang, Xiaoting & Yang, Jun, 2014. "Asymmetric contracts, cash flows and risk taking of mutual funds," Economic Modelling, Elsevier, vol. 38(C), pages 435-442.
    9. 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.
    10. Rudiger, Jesper & Vigier, Adrien, 2013. "Financial Experts, Asset Prices and Reputation," MPRA Paper 51784, University Library of Munich, Germany.
    11. Veronica Guerrieri & Peter Kondor, 2012. "Fund Managers, Career Concerns, and Asset Price Volatility," American Economic Review, American Economic Association, vol. 102(5), pages 1986-2017, August.
    12. 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.
    13. Jiang, Hao & Sun, Zheng, 2014. "Dispersion in beliefs among active mutual funds and the cross-section of stock returns," Journal of Financial Economics, Elsevier, vol. 114(2), pages 341-365.
    14. Andrea M. Buffa & Dimitri Vayanos & Paul Woolley, 2014. "Asset Management Contracts and Equilibrium Prices," NBER Working Papers 20480, National Bureau of Economic Research, Inc.

    More about this item

    Keywords

    agency; delegation; equilibrium; funds; money management;

    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G19 - Financial Economics - - General Financial Markets - - - Other
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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