On the Optimal Strategy for the Hedge Fund Manager: An Experimental Investigation
36 Pages Posted: 11 Jun 2019
Date Written: May 21, 2019
This paper examines the empirical validity of Nicolosi’s model (2018) which investigates the optimal strategy for a hedge fund manager under a specific payment contract. The contract specifies that the manager’s payment consists of a fixed payment and a variable payment, which is based on the over-performance with respect to a pre-specified benchmark. The model assumes that the manager is an Expected Utility agent who maximises his or her expected utility by buying and selling the asset at appropriate moments. Nicolosi derives the optimal strategy for the manager. To find this, Nicolosi assumes a Black-Scholes setting where the manager can invest either in an asset or in a money account. The asset price follows geometric Brownian motion and the money account has a constant interest rate. I experimentally test Nicolosi’s model. To meet the aim of this paper, I compare the empirical support of Nicolosi’s story with other possible strategies. The results show that Nicolosi’s model receives strong empirical support for explaining the subjects’ behaviour, though not all of the subjects follow Nicolosi’s model. Having said this, it seems that the subjects somehow follow the intuitive prediction of Nicolosi’s model in which the decision-maker responds to the difference between the managed portfolio and the benchmark to determine the portfolio allocation.
Keywords: fund manager, portfolio strategy, laboratory experiment
JEL Classification: G11, C91
Suggested Citation: Suggested Citation