Optimal Decentralized Investment Management

68 Pages Posted: 2 Mar 2006

See all articles by Jules H. van Binsbergen

Jules H. van Binsbergen

University of Pennsylvania - The Wharton School; National Bureau of Economic Research (NBER)

Michael W. Brandt

Duke University - Fuqua School of Business; National Bureau of Economic Research (NBER)

Ralph S. J. Koijen

University of Chicago - Booth School of Business; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: October 19, 2006

Abstract

We study an institutional investment problem in which a centralized decision maker, the Chief Investment Officer (CIO), for example, employs multiple asset managers to implement and execute investment strategies in separate asset classes. The CIO allocates capital to the managers who, in turn, allocate these funds to the assets in their asset class. This two-step investment process causes several misalignments of objectives between the CIO and his managers and can lead to large utility costs on the part of the CIO. We focus on (i) loss of diversification, (ii) unobservable appetites for risk of the managers, and (iii) different investment horizons. We derive an optimal unconditional linear performance benchmark and show that this benchmark can be used to better align incentives within the firm. We find that the CIO's uncertainty about the managers' risk appetites increases both the costs of decentralized investment management and the value of an optimally designed benchmark.

Keywords: Decentralized investment management, performance benchmark

JEL Classification: G0, G11, G23, G24

Suggested Citation

van Binsbergen, Jules H. and Brandt, Michael W. and Koijen, Ralph S. J., Optimal Decentralized Investment Management (October 19, 2006). EFA 2006 Zurich Meetings; AFA 2007 Chicago Meetings Paper. Available at SSRN: https://ssrn.com/abstract=887399 or http://dx.doi.org/10.2139/ssrn.887399

Jules H. Van Binsbergen

University of Pennsylvania - The Wharton School ( email )

3641 Locust Walk
Philadelphia, PA 19104-6365
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

HOME PAGE: http://www.nber.org/people/jules_vanbinsbergen

Michael W. Brandt

Duke University - Fuqua School of Business ( email )

1 Towerview Drive
Durham, NC 27708-0120
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Ralph S. J. Koijen (Contact Author)

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/ralph.koijen/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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