Delegated Portfolio Management under Ambiguity Aversion

27 Pages Posted: 8 Feb 2014 Last revised: 17 Feb 2015

See all articles by Annalisa Fabretti

Annalisa Fabretti

University of Rome Tor Vergata - Tor Vergata Economics University Foundation

Stefano Herzel

University of Rome Tor Vergata - Faculty of Economics

Mustafa Pinar

Bilkent University - Department of Industrial Engineering

Date Written: December 11, 2013

Abstract

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 off ered 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.

Keywords: Delegated Portfolio Management, ambiguity, robust optimization

Suggested Citation

Fabretti, Annalisa and Herzel, Stefano and Pinar, Mustafa, Delegated Portfolio Management under Ambiguity Aversion (December 11, 2013). CEIS Working Paper No. 304, Available at SSRN: https://ssrn.com/abstract=2391898 or http://dx.doi.org/10.2139/ssrn.2391898

Annalisa Fabretti (Contact Author)

University of Rome Tor Vergata - Tor Vergata Economics University Foundation ( email )

Via Columbia 2
Rome, 00133
Italy

Stefano Herzel

University of Rome Tor Vergata - Faculty of Economics ( email )

Via Columbia n.2
Rome, rome 00100
Italy

Mustafa Pinar

Bilkent University - Department of Industrial Engineering ( email )

Ankara, 06800
Turkey

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