Abstract
This paper examines the empirical validity of Nicolosi’s story (2018) which investigates the optimal strategy for a hedge fund manager under a specific payment contract. The contract specifies that the manager’s payment consists of a fixed payment and a variable payment, which is based on the over-performance with respect to a pre-specified benchmark. The model assumes that the manager is an Expected Utility agent who maximises his expected utility by buying and selling the asset at appropriate moments. Nicolosi derives the optimal strategy for the manager. To find this, Nicolosi assumes a Black-Scholes setting where the manager can invest either in an asset or in a money account. The asset price follows geometric Brownian motion and the money account has a constant interest rate. I experimentally test Nicolosi’s story. To meet the aim of this paper, I compare the empirical support of Nicolosi’s story with other possible strategies. The results show that Nicolosi’s story receives the strong empirical support to explain the subjects’ behaviour, though not most of the subjects follow Nicolosi’s story. Despite this, the subjects somehow follow the intuitive prediction of Nicolosi’s story where the subjects respond to the difference between their managed portfolio and the benchmark to determine their portfolio allocation.
Keywords: fund manager, portfolio strategy, lab-experiment.
A submitted paper. Avaliable on https://papers.ssrn.com/sol3/papers.cfm?abstract_id=3394439