The paper “Delegated Asset Management and Market Segmentation” will be presented by Dr Zhiguo Graduate Business School, University of Chicago.
Abstract
This paper studies optimal contracting in delegated asset management when a fund manager exerts unobservable effort and takes unobservable investment positions in multiple markets. Implementing a seemingly sub-optimal investment strategy that confines the fund to investing in a single market can be optimal, because the benefit from increasing incentive provision efficiency through more precise benchmarking can dominate the cost of forgone investment opportunities in other markets. Our model thus justifies the widely used capital confinement provisions in asset management contracts and relates them to proxies of fund managers’ agency cost. By establishing capital immobility from the originating end of capital flow rather than the receiving end, our model offers a novel explanation to a puzzling phenomenon that liquidity crises could occur in certain market segments despite adequate capital available in the economy.