Mutual Fund Tournament: Risk Taking Incentives Induced by Ranking Objectives

44 Pages Posted: 17 May 2001

See all articles by Alexei Goriaev

Alexei Goriaev

New Economic School

Frederic Palomino

Centre for Economic Policy Research (CEPR)

Andrea Prat

Columbia University - Columbia Business School, Finance; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2001

Abstract

There is now extensive empirical evidence showing that fund managers have relative performance objectives and adapt their investment strategy in the last part of the calendar year to balance their performance in the early part of the year. However, emphasis was put on returns in excess of some exogenous benchmark return. In this Paper, we investigate whether fund managers have ranking objectives (as in a tournament). First, in a two-period model, we analyse the game played by two risk-neutral fund managers with ranking objectives. We show that ranking objectives provide incentives for an interim loser to increase risk in the last part of the year. In the second part of the Paper, we test some predictions of the model. We find evidence that funds ranked in the top decile after the first part of the year have risk incentives generated by ranking objectives and that risk induced by ranking objectives is mainly systematic.

Keywords: Interim performance, ranking-based objectives, risk-taking incentives

JEL Classification: G11, G24

Suggested Citation

Goriaev, Alexei and Palomino, Frederic Albert and Prat, Andrea, Mutual Fund Tournament: Risk Taking Incentives Induced by Ranking Objectives (May 2001). Available at SSRN: https://ssrn.com/abstract=270304

Alexei Goriaev (Contact Author)

New Economic School ( email )

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HOME PAGE: http://www.nes.ru/~agoriaev/

Frederic Albert Palomino

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Andrea Prat

Columbia University - Columbia Business School, Finance ( email )

3022 Broadway
New York, NY 10027
United States

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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