The delegated Lucas tree

Ron Kaniel and Péter Kondor

No 8578, CEPR Discussion Papers from C.E.P.R. Discussion Papers

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.

Keywords: Delegation; Agency; Equilibrium; Money management; Funds (search for similar items in EconPapers)
JEL-codes: G11 G12 G19 G29 (search for similar items in EconPapers)
Date: 2011-09
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (2)

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Related works:
Journal Article: The Delegated Lucas Tree (2013)
Working Paper: The delegated Lucas tree (2011)
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