Delegation Uncertainty

Ye Li and Chen Wang
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Ye Li: Ohio State University
Chen Wang: Yale School of Management

Working Paper Series from Ohio State University, Charles A. Dice Center for Research in Financial Economics

Abstract: Delegation bears an intrinsic form of uncertainty. Investors hire managers for their superior models of asset markets, but delegation outcome is uncertain precisely because managers' model is unknown to investors. We model investors' delegation decision as a trade-off between asset return uncertainty and delegation uncertainty. Our theory explains several puzzles on fund performances. It also delivers asset pricing implications supported by our empirical analysis: (1) because investors partially delegate and hedge against delegation uncertainty, CAPM alpha arises; (2) the cross-section dispersion of alpha increases in uncertainty; (3) managers bet on alpha, engaging in factor timing, but factors' alpha is immune to the rise of their arbitrage capital--when investors delegate more, delegation hedging becomes stronger. Finally, we offer a novel approach to extract model uncertainty from asset returns, delegation, and survey expectations.

JEL-codes: D53 D81 D83 D84 G11 G40 (search for similar items in EconPapers)
Date: 2018-11
New Economics Papers: this item is included in nep-ore
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Persistent link: https://EconPapers.repec.org/RePEc:ecl:ohidic:2018-22

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