Optimal contract for a fund manager, with capital injections and endogenous trading constraints

TL;DR

This paper develops a robust optimal contract framework for fund managers that accounts for capital injections and endogenous trading constraints, using SPDEs to characterize solutions in a stochastic setting.

Contribution

It introduces a novel approach to optimal contracts that are robust to wealth perturbations and incorporate strategy-dependent objectives, extending prior models.

Findings

Robustness of the optimal contract to capital injections.

Inclusion of strategy-dependent principal objectives.

Explicit solution in the Black-Scholes model.

Abstract

In this paper, we construct a solution to the optimal contract problem for delegated portfolio management of the fist-best (risk-sharing) type. The novelty of our result is (i) in the robustness of the optimal contract with respect to perturbations of the wealth process (interpreted as capital injections), and (ii) in the more general form of principals objective function, which is allowed to depend directly on the agents strategy, as opposed to being a function of the generated wealth only. In particular, the latter feature allows us to incorporate endogenous trading constraints in the contract. We reduce the optimal contract problem to the following inverse problem: for a given portfolio (defined in a feedback form, as a random field), construct a stochastic utility whose optimal portfolio coincides with the given one. We characterize the solution to this problem through a Stochastic Partial Differential Equation (SPDE), prove its well-posedness, and compute the solution explicitly in the Black-Scholes model.