Optimal management fee and portfolio choice of institutional investors in a continuous-time model

Abstract

By stochastic dynamic programming setting, we derive a closed-form solution to optimal management fee and dynamic asset allocation strategy of institutional investors. We found that the optimal management fee is dependent upon managed assets, the rate of time preference, the relative risk aversion coefficient, the sensitivity of relative flow to performance, and the relative benchmark portfolio. There are two components, the benchmark hedge component and the myopic component, in the optimal dynamic asset allocation strategy of institutional investors. Both the benchmark hedge component and the myopic component are influenced by the sensitivity of relative flow to performance. Besides, the myopic component is consistent with common knowledge of investment decision and provides a possible solution to asset allocation puzzle. Key words: Management fee, dynamic asset allocation, institutional investor.