Working Paper: CEPR ID: DP8457
Authors: Suleyman Basak; Dmitry Makarov
Abstract: Money managers behave strategically when competing for fund flows within relatively small groups. We study strategic interaction between two risk-averse managers in continuous time, characterizing analytically their unique equilibrium dynamic investments. Driven by chasing and contrarian mechanisms when one is well ahead, they gamble in the opposite direction when their performances are close. We also discuss multiple and mixed-strategy equilibria. Equilibrium policy of each crucially depends on the opponent?s risk attitude. Hence, client investors, concerned about how a strategic manager may trade on their behalf, should also learn competitors? characteristics--as against non-strategic settings, where knowing a manager?s own characteristics suffices to determine behavior.
Keywords: Fund flows; Incentives; Money managers; Portfolio choice; Relative performance; Risk shifting; Strategic interactions; Tournaments
JEL Codes: C61; C73; D81; G11; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| strategic interactions among money managers (G11) | dynamic investments characterized by chasing and contrarian behaviors (G41) |
| one manager is significantly ahead (L25) | they may gamble in the opposite direction of their competitor (L83) |
| relative performance of the managers (L25) | equilibrium investment policies (G11) |
| managers are close in performance (D29) | they exhibit gambling behavior (L83) |
| gambling behavior (L83) | non-existence or multiplicity of equilibrium (C62) |
| risk attitudes of the managers (D81) | nature of these equilibria (D50) |