Faculty of Economics and Business Administration Publications Database

Continous-Time Delegated Portfolio Management with Homogeneous Expectations

Korn, Ralf
Volume: 22
Number: 1
Pages: 67 - 90
Month: March
ISSN-Print: 1555-4961
Link External Source: Online Version
Year: 2008
Keywords: Delegated portfolio decision; Principal-agent theory; Quadratic contract; Exchange option; Growth optimal portfolio; Merton portfolio problem

In a continuous-time framework, the issue of how to delegate an investor’s portfolio decision to a portfolio manager is studied. First, we solve the first-best problem. For the second-best case, a specific quadratic contract is introduced resolving the agency conflict completely in the sense that the solutions to the first-best and second-best problems coincide. This contract can be implemented if the investor is able to observe the value of the growth optimal portfolio at her investment horizon. If the investment opportunity set is assumed to be constant, in equilibrium the value of the market portfolio is a sufficient statistic for the value of the growth optimal portfolio. Throughout the paper, we assume that the investor and the manager have homogeneous expectations about the investment opportunity set. This, however, does not necessarily mean that investor and manager are symmetrically informed about all prices.