Abstract

http://ssrn.com/abstract=896216
 
 

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Optimal Decentralized Investment Management


Michael W. Brandt


Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Jules H. Van Binsbergen


University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Ralph S. J. Koijen


London Business School - Department of Finance; National Bureau of Economic Research (NBER)

April 2006

NBER Working Paper No. w12144

Abstract:     
We study a decentralized investment problem in which a CIO employs multiple asset managers to implement and execute investment strategies in separate asset classes. The CIO allocates capital to the managers who, in turn, allocate these funds to the assets in their asset class. This two-step investment process causes several misalignments of objectives between the CIO and his managersand can lead to large utility costs on the part of the CIO. We focus on i) loss of diversification ii) different appetites for risk, iii) different investment horizons, and iv) the presence of liabilities. We derive an optimal unconditional linear performance benchmark and show that this benchmark can be used to better align incentives within the firm. The optimal benchmark substantially mitigates the utility costs of decentralized investment management. These costs can be further reduced when the CIO can screen asset managers on the basis of their risk appetites. Each manager%u2019s optimal level of risk aversion depends on the asset class he manages and can differ substantially from the CIO%u2019s level of risk aversion.

Number of Pages in PDF File: 61

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Date posted: May 18, 2006  

Suggested Citation

Brandt, Michael W. and van Binsbergen, Jules H. and Koijen, Ralph S. J., Optimal Decentralized Investment Management (April 2006). NBER Working Paper No. w12144. Available at SSRN: http://ssrn.com/abstract=896216

Contact Information

Michael W. Brandt (Contact Author)
Duke University - Fuqua School of Business ( email )
1 Towerview Drive
Durham, NC 27708-0120
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Jules H. Van Binsbergen
University of Pennsylvania - The Wharton School ( email )
3641 Locust Walk
Philadelphia, PA 19104-6365
United States
National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
HOME PAGE: http://www.nber.org/people/jules_vanbinsbergen
Ralph S. J. Koijen
London Business School - Department of Finance ( email )
Sussex Place
Regent's Park
London NW1 4SA
United Kingdom
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
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