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The delegated Lucas tree

Author

Listed:
  • Kaniel, Ron
  • Kondor, Péter
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.

Suggested Citation

  • Kaniel, Ron & Kondor, Péter, 2011. "The delegated Lucas tree," CEPR Discussion Papers 8578, C.E.P.R. Discussion Papers.
    • Handle: RePEc:cpr:ceprdp:8578
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    More about this item

    Keywords

    Delegation; Agency; Equilibrium; Money management; Funds;
    All these keywords.

    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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