Strategic Asset Allocation in Money Management

Suleyman Basak and Dmitry Makarov ()

No w0158, Working Papers from Center for Economic and Financial Research (CEFIR)

Abstract: 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.

Keywords: Money Managers; Strategic Interaction; Portfolio Choice; Relative Performance; Incentives; Risk Shifting; Fund Flows; Tournaments (search for similar items in EconPapers)
JEL-codes: C61 C73 D81 G11 G20 (search for similar items in EconPapers)
Pages: 42 pages
Date: 2009-08
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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http://www.cefir.ru/papers/WP158.pdf (application/pdf)

Related works:
Journal Article: Strategic Asset Allocation in Money Management (2014)
Working Paper: Strategic Asset Allocation in Money Management (2011)
Working Paper: Strategic Asset Allocation in Money Management (2009)
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Persistent link: https://EconPapers.repec.org/RePEc:cfr:cefirw:w0158

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