Statistics Seminar（2013-15）

Topic:Delegated Portfolio Management under Adverse Selection in a Continuous-Time Model

Speaker:Nengjiu Ju, Shanghai Jiaotong University

Time:Thursday, 24 October, 14:00-16:00

Location:Room 217, Guanghua Building 2

Abstract：This paper studies the optimal contracting problem between a representative fund investor and a constant absolute risk-aversion fund manager whose skill is unobservable by the investor. The optimal compensation contract and the manager’s optimal fund investment policy are derived in closed form. Several interesting results are obtained. First, the optimal contract involves an incentive fee which is symmetric around a market-based benchmark, complementing existing result on the optimality of symmetric incentive fees when the investor and the manager have symmetric information and justifying the use of such fees even when there is asymmetric information. Second, the investor optimally pays a more efficient manager more cash for his better skill and incentivizes a less efficient manager with the performance of his trading in the stock. The optimal compensation contains cash and an active benchmark portfolio. Both the cash and the stock holding in the benchmark portfolio are higher for a more efficient manager. A less efficient manager outperforms his lower benchmark and obtains a higher incentive pay in bull markets. Third, the time pattern of stock investment can exhibit non-monotone behavior. An efficient manager’s investment in the stock decays through time whereas an inefficient manager’s trading decreases initially and then increases near the investment horizon. In addition, we make two methodological contributions. First, we show that, under certain conditions, there exists an optimal linear contract which consists of the terminal wealth of the portfolio minus a market-based component. Second, we show how to design a linear contract which induces the manager to truthfully report his type and adopt a trading policy which is optimal for the reported type.