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In theory, investors knowledgeable of their risk aversion should choose their portfolios by either maximizing return for a given risk or minimizing risk for a target return. Risk is typically measured with the standard deviation of returns. In reality, however, most of the investments are managed by organizations that differ from the investor. This creates a layer of asymmetric information as the investor does not directly observe neither the skills nor the effort of the asset manager. This issue is known in the literature as the fund delegation problem (Stracca (2005)).
Basically, the investor, or more exactly the regulator on behalf of the investor, has to develop compensation rules and monitoring rules to control the manager. Applied to funds, this implies the current...
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