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A Model of Portfolio Delegation and Strategic Trading

47 Pages Posted: 17 Mar 2009 Last revised: 16 Jul 2010

Albert S. Kyle

University of Maryland

Hui Ou-Yang

Cheung Kong Graduate School of Business

Bin Wei

Federal Reserve Bank of Atlanta

Date Written: May 1, 2010

Abstract

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.

Keywords: Portfolio Delegation, Information Acquisition, Strategic Trading, Price Informativeness

JEL Classification: G14, G12, G11

Suggested Citation

Kyle, Albert S. and Ou-Yang, Hui and Wei, Bin, A Model of Portfolio Delegation and Strategic Trading (May 1, 2010). Available at SSRN: https://ssrn.com/abstract=1360783 or http://dx.doi.org/10.2139/ssrn.1360783

Albert (Pete) S. Kyle

University of Maryland ( email )

College Park
College Park, MD 20742
United States

Hui Ou-Yang

Cheung Kong Graduate School of Business ( email )

Hong Kong
China
852-5199-6227 (Phone)

Bin Wei (Contact Author)

Federal Reserve Bank of Atlanta ( email )

1000 Peachtree Street N.E.
Atlanta, GA 30309-4470
United States

HOME PAGE: http://https://www.frbatlanta.org/research/economists/wei-bin.aspx

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