Abstract

http://ssrn.com/abstract=1316667
 
 

References (22)



 
 

Citations (34)



 


 



High-Water Marks: High Risk Appetites? Convex Compensation, Long Horizons, and Portfolio Choice


Stavros Panageas


University of Chicago - Booth School of Business; National Bureau of Economic Research (NBER)

Mark M. Westerfield


University of Washington

August 2007

Journal of Finance, February 2009

Abstract:     
We study the optimal portfolio choice of hedge fund managers who are compensated by high-water mark contracts. Surprisingly, we find that even risk-neutral managers will not place unboundedly large weights on the risky assets, despite the option-type features of the contract. Instead they will place a constant fraction of assets in a mean-variance efficient portfolio and the rest in the riskless asset, similar to investors with constant relative risk aversion. This result is a direct consequence of the indefinite horizon of the contract. We argue more generally that the risk-seeking incentives of option-type compensation contracts rely on the interaction of convex compensation and finite horizons, rather than on the convexity of the compensation scheme alone.

Number of Pages in PDF File: 49

Keywords: Performance evaluation, Hedge funds, Option-type compensation, High-water marks, Continuous time

JEL Classification: G11, G2

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Date posted: December 17, 2008  

Suggested Citation

Panageas, Stavros and Westerfield, Mark M., High-Water Marks: High Risk Appetites? Convex Compensation, Long Horizons, and Portfolio Choice (August 2007). Journal of Finance, February 2009. Available at SSRN: http://ssrn.com/abstract=1316667

Contact Information

Stavros Panageas (Contact Author)
University of Chicago - Booth School of Business ( email )
5807 S. Woodlawn Avenue
Chicago, IL 60637
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Mark M. Westerfield
University of Washington ( email )
Box 353200
Seattle, WA 98195
United States
HOME PAGE: http://www.markwesterfield.com
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