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Difference in Interim Performance and Risk Taking with Short-Sale Constraints

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Dmitry Makarov

ICEF, Higher School of Economics

September 10, 2011

Absent much theory, empirical works often rely on the following informal reasoning when looking for evidence of a mutual fund tournament: If there is a tournament, interim winners have incentives to decrease their portfolio volatility as they attempt to protect their lead, while interim losers are expected to increase their volatility so as to catch up with winners. We consider a rational model of a mutual fund tournament in the presence of short-sale constraints and find the opposite: Interim winners choose more volatile portfolios in equilibrium than interim losers. Several empirical works present evidence consistent with our model. However, based on the above informal argument, they appear to conclude against the tournament behavior. We argue that this conclusion is unwarranted. We also demonstrate that tournament incentives lead to differences in interim performance for otherwise identical managers and that mid-year trading volume is inversely related to mid-year stock return.

Number of Pages in PDF File: 38

Keywords: Relative Performance, Risk-Taking Incentives, Portfolio Choice, Short-Sale Constraints

JEL Classification: G11, G20, D81

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Date posted: March 9, 2008 ; Last revised: September 10, 2011

Suggested Citation

Basak, Suleyman and Makarov, Dmitry, Difference in Interim Performance and Risk Taking with Short-Sale Constraints (September 10, 2011). Available at SSRN: https://ssrn.com/abstract=1103042 or http://dx.doi.org/10.2139/ssrn.1103042

Contact Information

Suleyman Basak
London Business School ( email )
Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)
HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Dmitry Makarov (Contact Author)
ICEF, Higher School of Economics ( email )
26 Shabolovka
HOME PAGE: http://www.nes.ru/~dmakarov
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