Explicit and Implicit Incentives in Delegated Portfolio Management
Federal Reserve Board
March 18, 2009
AFA 2010 Atlanta Meetings Paper
Investors can incentivize a fund manager by assigning a compensation contract to provide explicit incentives, or by adjusting fund flows to provide implicit incentives, or both. In this paper based on a tractable dynamic model we show that the interplay between the explicit and implicit incentives is important in accounting for a puzzling phenomenon in the mutual fund industry, namely, the convex flow-performance relationship whereby disproportionate amounts of new money flow into funds with superior recent performance while less money escapes from funds with poor performance. Furthermore, this paper sheds new light on asset pricing implications of portfolio delegation; in particular, we show that introducing delegated portfolio management increases stock return volatility and reduces unconditional stock risk premium.
Number of Pages in PDF File: 55
Keywords: Portfolio Delegation, Managerial Ability, Implicit/Explicit Incentives
JEL Classification: G11, G12, G21working papers series
Date posted: March 21, 2009 ; Last revised: December 21, 2009
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