The Delegated Lucas Tree

64 Pages Posted: 29 Sep 2011

See all articles by Ron Kaniel

Ron Kaniel

University of Rochester - Simon Business School; CEPR

Peter Kondor

London School of Economics & Political Science (LSE); Central European University (CEU)

Date Written: September 2011


We analyze the effects of the observed increased share of delegated capital for trading strategies and equilibrium prices. We introduce delegation into a standard Lucas exchange economy, where in equilibrium some investors trade on their own account, but others decide to delegate trading to professional fund managers. Flow-performance incentive functions describe how much capital clients provide to funds at each date as a function of past performance. Convex flow-performance relations imply that the average fund outperforms the market in recessions and underperforms in expansions. When the share of capital that is delegated is low, all funds follow the same strategy. However, when the equilibrium share of delegated capital is high funds with identical incentives employ heterogeneous trading strategies. A group of managers borrow to take on a levered position on the stock. Thus, fund returns are dispersed in the cross-section and the outstanding amounts of borrowing and lending increase. The relation between the share of delegated capital and the Sharpe ratio typically follows an inverse U-shape pattern.

Keywords: agency, delegation, equilibrium, funds, money management

JEL Classification: G11, G12, G19, G29

Suggested Citation

Kaniel, Ron and Kondor, Peter, The Delegated Lucas Tree (September 2011). CEPR Discussion Paper No. DP8578. Available at SSRN:

Ron Kaniel (Contact Author)

University of Rochester - Simon Business School ( email )

Rochester, NY 14627
United States


CEPR ( email )

United Kingdom

Peter Kondor

London School of Economics & Political Science (LSE) ( email )

Houghton Street
London, WC2A 2AE
United Kingdom


Central European University (CEU) ( email )

Nador utca 9
Budapest, H-1051

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