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The delegated Lucas tree

Author

Listed:
  • Péter Kondor

    (Central European University)

  • Ron Kaniel

    (Duke University)

Abstract

We analyze the effects of the observed increased share of delegated capital for trading strategies and equilibrium prices. We introduce delegation into a standard Lucas exchange economy, where 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 borrow 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

  • Péter Kondor & Ron Kaniel, 2011. "The delegated Lucas tree," 2011 Meeting Papers 580, Society for Economic Dynamics.
    • Handle: RePEc:red:sed011:580
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    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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