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

38 Pages Posted: 9 Mar 2008 Last revised: 10 Sep 2011

Suleyman Basak

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

Dmitry Makarov

ICEF, Higher School of Economics

Multiple version iconThere are 2 versions of this paper

Date Written: September 10, 2011

Abstract

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.

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

JEL Classification: G11, G20, D81

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

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
Moscow
Russia

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

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