A Model of Portfolio Delegation and Strategic Trading
Albert S. Kyle
University of Maryland; National Bureau of Economic Research (NBER)
Cheung Kong Graduate School of Business
Board of Governors of the Federal Reserve System (FRB)
May 1, 2010
This paper endogenizes information acquisition and portfolio delegation in a one-period strategic trading model. The equilibrium concept constrains prices, demands, and contracts to be linear functions. We find that when the informed portfolio manager is relatively risk tolerant (averse), price informativeness increases (decreases) with the amount of noise trading. Our results differ from those obtained in the traditional market microstructure literature, in which price informativeness is independent of or decreases with the amount of noise trading. When noise trading is endogenized, the linear equilibrium in the traditional literature breaks down under a wide range of parameter values regarding the number, the risk aversion, and the endowment risk of noise traders. In contrast, a linear equilibrium always exists in our model. In a conventional portfolio delegation model under a competitive partial equilibrium, the manager's effort of acquiring information is independent of a linear incentive contract. In our strategic trading model, however, a higher powered linear contract induces the manager to exert more effort for information acquisition, but the manager's trading intensity can be either higher or lower.
Number of Pages in PDF File: 47
Keywords: Portfolio Delegation, Information Acquisition, Strategic Trading, Price Informativeness
JEL Classification: G14, G12, G11
Date posted: March 17, 2009 ; Last revised: July 16, 2010
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