Abstract

http://ssrn.com/abstract=1754634
 
 

References (19)



 
 

Citations (3)



 


 



The Economics of Hedge Funds: Alpha, Fees, Leverage, and Valuation


Yingcong Lan


Cornerstone Research - New York Office

Neng Wang


Columbia Business School - Finance and Economics

Jinqiang Yang


Shanghai University of Finance and Economics

January 31, 2011


Abstract:     
Hedge fund managers are compensated via management fees on the assets under management (AUM) and incentive fees indexed to the high-water mark (HWM). We study the effects of managerial skills (alpha) and compensation on dynamic leverage choices and the valuation of fees and investors' payoffs. Increasing the investment allocation to the alpha-generating strategy typically lowers the fund's risk-adjusted excess return due to frictions such as price pressure. When the manager is only paid via management fees, the manager optimally chooses time-invariant leverage to balance the size of allocation to the alpha-generating strategy against the negative impact of increasing size on the fund's alpha. When the manager is paid via both management and incentive fees, we show that (i) the high-powered incentive fees encourage excessive risk taking, while management fees have the opposite effect; (ii) conflicts of interest between the manager and investors have significant effects on dynamically changing leverage choices and the valuation of fees and investors' payoffs; (iii) the manager optimally increases leverage following strong fund performances; (iv) investors' options to liquidate the fund following sufficiently poor fund performances substantially curtail managerial risk-taking, provide strong incentives to de-leverage, and sometimes even give rise to strong precautionary motives to hoard cash (in long positions); and (v) managerial ownership concentration has incentive alignment effects.

Number of Pages in PDF File: 44

Keywords: assets under management (AUM), high-water mark, alpha, management fees, incentive fees, conflicts of interest, liquidation option, managerial ownership

JEL Classification: G2, G32

working papers series


Download This Paper

Date posted: February 4, 2011 ; Last revised: March 16, 2011

Suggested Citation

Lan, Yingcong and Wang, Neng and Yang, Jinqiang, The Economics of Hedge Funds: Alpha, Fees, Leverage, and Valuation (January 31, 2011). Available at SSRN: http://ssrn.com/abstract=1754634 or http://dx.doi.org/10.2139/ssrn.1754634

Contact Information

Yingcong Lan
Cornerstone Research - New York Office ( email )
599 Lexington Avenue
New York, NY 10022
United States
Neng Wang (Contact Author)
Columbia Business School - Finance and Economics ( email )
3022 Broadway
New York, NY 10027
United States

Jinqiang Yang
Shanghai University of Finance and Economics ( email )
777 Guoding Road
Shanghai, Shanghai 200433
China
Feedback to SSRN


Paper statistics
Abstract Views: 798
Downloads: 163
Download Rank: 91,123
References:  19
Citations:  3
People who downloaded this paper also downloaded:
1. The Economics of Hedge Funds
By Yingcong Lan, Neng Wang, ...

© 2014 Social Science Electronic Publishing, Inc. All Rights Reserved.  FAQ   Terms of Use   Privacy Policy   Copyright   Contact Us
This page was processed by apollo8 in 0.297 seconds