Competition among Portfolio Managers and Asset Specialization

44 Pages Posted: 4 Mar 2010 Last revised: 9 Aug 2017

See all articles by Suleyman Basak

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Dmitry Makarov

ICEF, Higher School of Economics

Date Written: September 1, 2015

Abstract

This paper develops a tractable dynamic model of competition between two risk-averse portfolio managers who attempt to outperform each other by trading in different stocks, reflecting asset specialization. We characterize explicitly the unique Nash equilibrium portfolio policies, and show that a risk tolerant manager decreases, and a risk intolerant increases, her portfolio risk due to competition. Contrary to the standard result without competition, a higher risk aversion could well incentivize more risk taking. We also show that competition can be conducive to asset specialization, and hence under-diversification, in that both managers, when risk tolerant, prefer to restrict their investment sets to avoid competing on the same turf by trading in the same set of stocks. Such under-diversification could impose substantial costs on the managers' client investors. The clients also lose when the risk-return profile of their investments deviates from the optimal level due to managerial turnover or changing stock characteristics. The client's loss is higher when it is her manager who is replaced rather than the other manager. But surprisingly that loss is the same whether a given change in stock characteristics applies to her manager's stock or to the competitor's stock to which she has no direct exposure.

Keywords: Competition, Portfolio Choice, Asset Specialization, Under-Diversification, Cost-Benefit Analysis, Relative Performance

JEL Classification: G11, G20, D81, C73, C61

Suggested Citation

Basak, Suleyman and Makarov, Dmitry, Competition among Portfolio Managers and Asset Specialization (September 1, 2015). Available at SSRN: https://ssrn.com/abstract=1563567 or http://dx.doi.org/10.2139/ssrn.1563567

Suleyman Basak

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)

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

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Dmitry Makarov (Contact Author)

ICEF, Higher School of Economics ( email )

26 Shabolovka
Moscow
Russia

HOME PAGE: http://www.nes.ru/~dmakarov

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