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Optimal Decentralized Investment Management

61 Pages Posted: 18 May 2006 Last revised: 8 Sep 2010

Michael W. Brandt

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

Jules H. van Binsbergen

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

Ralph S. J. Koijen

New York University (NYU) - Department of Finance; Centre for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: April 2006

Abstract

We study a decentralized investment problem in which a CIO 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 managersand can lead to large utility costs on the part of the CIO. We focus on i) loss of diversification ii) different appetites for risk, iii) different investment horizons, and iv) the presence of liabilities. We derive an optimal unconditional linear performance benchmark and show that this benchmark can be used to better align incentives within the firm. The optimal benchmark substantially mitigates the utility costs of decentralized investment management. These costs can be further reduced when the CIO can screen asset managers on the basis of their risk appetites. Each manager%u2019s optimal level of risk aversion depends on the asset class he manages and can differ substantially from the CIO%u2019s level of risk aversion.

Suggested Citation

Brandt, Michael W. and van Binsbergen, Jules H. and Koijen, Ralph S. J., Optimal Decentralized Investment Management (April 2006). NBER Working Paper No. w12144. Available at SSRN: https://ssrn.com/abstract=896216

Michael W. Brandt (Contact Author)

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

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

Ralph S. J. Koijen

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

HOME PAGE: http://www.koijen.net

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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