Delegated Portfolio Management under Ambiguity Aversion

Fabretti Annalisa Herzel StefanoPinar Mustafa C.
CEIS Research Paper
We examine the problem of setting optimal incentives for a portfolio manager hired by an investor who wants to induce ambiguity-robust portfolio choices with respect to estimation errors in expected returns. We consider a one-period model with a set of risky assets (with multivariate normal returns) whose expected returns are estimated with uncertainty and a linear sharing rule between a risk-neutral investor and a risk averse portfolio manager. The manager accepts the contract if the compensation offered is at least as large as a minimum compensation he determines from his minimum acceptable utility level. Adopting a worst-case max-min approach we obtain in closed-form the optimal compensation in various cases where the investor and the manager, respectively adopt or relinquish an ambiguity averse attitude. We apply our result to compute the compensation fees for an investment strategy restricted by Socially Responsible rules. The application shows, for instance, that the additional premium requested by a manager for restricting the investment set should decrease when the aversion to ambiguity increases.
Number: 304
Keywords: Delegated Portfolio Management, ambiguity, robust optimization
Volume: 12
Issue: 02
Date: Thursday 06 February 2014
Revision Date: Thursday 06 February 2014