Delegated Asset Management, Investment Mandates, and Capital Immobility

45 Pages Posted: 15 Mar 2009 Last revised: 31 May 2012

See all articles by Zhiguo He

Zhiguo He

University of Chicago - Finance

Wei Xiong

Princeton University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: May 8, 2012

Abstract

This paper develops a model to explain the widely used investment mandates in the institutional asset management industry based on two insights: First, giving a manager more investment flexibility weakens the link between fund performance and his effort in the designated market, and thus increases agency cost. Second, the presence of outside assets with negatively skewed returns can further increase the agency cost if the manager is incentivized to pursue outside opportunities. These effects motivate narrow mandates and tight tracking error constraints to most fund managers except those with exceptional talents. Our model sheds light on capital immobility and market segmentation that are widely observed in financial markets, and highlights important effects of negatively skewed risk on institutional incentive structures.

Keywords: Institutional Frictions, Negatively Skewed Risk, Tracking Error Constraints, Market Segmentation

Suggested Citation

He, Zhiguo and Xiong, Wei, Delegated Asset Management, Investment Mandates, and Capital Immobility (May 8, 2012). Journal of Financial Economics (JFE), Forthcoming, Economic Theory Center Working Paper No. 39-2012, Available at SSRN: https://ssrn.com/abstract=1359436 or http://dx.doi.org/10.2139/ssrn.1359436

Zhiguo He (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
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United States

HOME PAGE: http://www.zhiguohe.com

Wei Xiong

Princeton University - Department of Economics ( email )

Princeton, NJ 08544-1021
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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