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Optimal decentralized investment management

Journal

Journal of Finance

Subject

Finance

Publishing details

Journal of Finance 2008 Vol 63:4 p 1849-1895

Authors / Editors

Jules H. Van Binsbergen;Michael W. Brandt;Ralph S. J. Koijen

Publication Year

2008

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 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 for the CIO. We focus on (1) loss of diversification, (2) unobservable managerial appetite for risk, and (3) 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.

Available on ECCH

No


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