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Paper Stats:
Abstract Views: 3220
Downloads: 880
Download Rank: 3182
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Explaining Hedge Fund Investment Styles by Loss Aversion: A Rational Alternative
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ARJEN SIEGMANN
Free University of Amsterdam - Faculty of Economics and Business Administration; Bank of the Netherlands - Research Department
ANDRE LUCAS
Free University Amsterdam - Faculty of Economics and Econometrics; Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)
May 7, 2002
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Abstract:
Recent research reveals that hedge fund returns exhibit a range of different, possibly non-linear pay-off patterns. It is difficult to qualify all these patterns simultaneously as being rational in a traditional framework for optimal financial decision making. In this paper we present a simple model based on loss aversion that can accommodate for all of these pay-off structures in one unifying framework. We provide evidence that loss-aversion is a likely assumption for management as well as investor preferences. Following the current empirical literature, we solve a static asset allocation problem that includes a nonlinear instrument. We show analytically that four different pay-off functions may be rationally optimal. The key parameter in determining which of these four to choose in a specific setting, is the financial planner's surplus. The notion of surplus connects hedge fund manager's incentive schemes with the idea of mental accounting as proposed in recent behavioral finance research.
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Keywords: hedge funds, performance measurement, loss aversion, behavioral finance
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JEL Classifications: G11, G23
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Working Paper Series
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Suggested Citation
Siegmann, Arjen and Lucas, Andre, "Explaining Hedge Fund Investment Styles by Loss Aversion: A Rational Alternative"
(May 7, 2002).
Available at SSRN: http://ssrn.com/abstract=302289
or DOI: 10.2139/ssrn.302289
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Contact Information for
ARJEN
SIEGMANN
(Contact Author)
Email address for ARJEN
SIEGMANN
Free University of Amsterdam - Faculty of Economics and Business Administration
De Boelelaan 1105
Dept. of Finance
1081 HV Amsterdam
Netherlands
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Email address for ARJEN
SIEGMANN
Bank of the Netherlands - Research Department
P.O. Box 98
1000 AB Amsterdam
Netherlands
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Contact Information for
ANDRE
LUCAS
Email address for ANDRE
LUCAS
Free University Amsterdam - Faculty of Economics and Econometrics
De Boelelaan 1105
1081 HV Amsterdam
Netherlands
+31 0 20 44 46039 (Phone)
+31 0 20 44 46005 (Fax)
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(No e-mail address available for ANDRE
LUCAS
Tinbergen Institute - Tinbergen Institute Amsterdam (TIA)
Roetersstraat 31
1018 WB Amsterdam
Netherlands
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