The Use of Derivatives by Investment Managers and Implications for Portfolio Performance and Risk
Kingsley Y. L. Fong
University of New South Wales - School of Banking and Finance; Financial Research Network (FIRN)
University of New South Wales (UNSW) - School of Banking and Finance
David R. Gallagher
Centre for International Finance and Regulation; The University of New South Wales - Australian School of Business; Macquarie Graduate School of Management
July 1, 2005
This study provides an empirical examination of derivative instruments used by institutional investors. Our analysis provides a unique insight into the role of derivative securities within portfolios, and the potential benefits from their use. We contribute to the literature using a database that comprises the periodic portfolio holdings and daily trades of active equity managers. The consequence of derivative use is analyzed using a number of performance and risk measures. Overall, we find the use of derivatives have a negligible impact on fund returns. This finding is attributed to low levels of derivative exposure relative to total fund size. We also evaluate how derivatives are used by considering the trading strategies executed by investment managers. The option trading patterns of active institutional investors are shown to be consistent with the execution of momentum trading strategies. The study also documents that active investment managers prefer not to use options markets to engage in informed trading.
Number of Pages in PDF File: 48
Keywords: Derivatives, managed funds, investment performance, portfolio risk
JEL Classification: G11, G23working papers series
Date posted: July 15, 2005
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