Contracting in Delegated Portfolio Management: The Case of Alternative Assets

42 Pages Posted: 15 Mar 2012 Last revised: 20 Sep 2013

See all articles by C. Wei Li

C. Wei Li

University of Iowa

Ashish Tiwari

University of Iowa

Date Written: August 13, 2013

Abstract

This study explores optimal portfolio management contracts in the context of ‘opaque’ portfolios invested in illiquid or privately held assets. We identify shortcomings of linear contracts in this context and demonstrate that the second-best optimal contract features a convex component. The importance of the convex component is an increasing function of the portfolio’s opacity. Furthermore, the principal’s utility loss from restricting the weight of the convex component to zero is increasing in the portfolio’s opacity. These results help provide a rationale for the form of contracts observed in the case of alternative investments including hedge funds and private equity funds.

Keywords: Delegated Portfolio Management, Incentive Contracts, Hedge Funds, Alternative Investments, Moral Hazard

JEL Classification: G20, G10

Suggested Citation

Li, C. Wei and Tiwari, Ashish, Contracting in Delegated Portfolio Management: The Case of Alternative Assets (August 13, 2013). Available at SSRN: https://ssrn.com/abstract=2022457 or http://dx.doi.org/10.2139/ssrn.2022457

C. Wei Li (Contact Author)

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business
Iowa City, IA 52242-1097
United States
319-335-0911 (Phone)
3193353690 (Fax)

Ashish Tiwari

University of Iowa ( email )

Finance Department
Henry B. Tippie College of Business, 108 PBB
Iowa City, IA 52242
United States
(319) 353-2185 (Phone)
(319) 335-3690 (Fax)

HOME PAGE: https://tippie.uiowa.edu/people/ashish-tiwari

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