DP8457 Strategic Asset Allocation in Money Management

Author(s): Suleyman Basak, Dmitry Makarov
Publication Date: June 2011
Keyword(s): fund flows, incentives, Money Managers, portfolio choice, relative performance, risk shifting, strategic interactions, tournaments
JEL(s): C61, C73, D81, G11, G20
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=8457

Money managers behave strategically when competing for fund flows within relatively small groups. We study strategic interaction between two risk-averse managers in continuous time, characterizing analytically their unique equilibrium dynamic investments. Driven by chasing and contrarian mechanisms when one is well ahead, they gamble in the opposite direction when their performances are close. We also discuss multiple and mixed-strategy equilibria. Equilibrium policy of each crucially depends on the opponent?s risk attitude. Hence, client investors, concerned about how a strategic manager may trade on their behalf, should also learn competitors? characteristics--as against non-strategic settings, where knowing a manager?s own characteristics suffices to determine behavior.