How Does Illiquidity Affect Delegated Portfolio Choice?

85 Pages Posted: 16 Feb 2009 Last revised: 12 Oct 2018

See all articles by Min Dai

Min Dai

National University of Singapore

Luis Goncalves-Pinto

University of New South Wales (UNSW)

Jing Xu

Renmin University of China - School of Finance

Date Written: February 18, 2018

Abstract

In response to how they are compensated, mutual fund managers who are under-performing by mid-year are likely to increase the risk of their portfolios towards the year-end. We argue that an increase in the liquidity of the stocks that managers use to shift risk can lead to an increase in the size of their risky bets. This in turn hurts fund investors by increasing the costs of misaligned incentives associated with delegated portfolio management. We provide both theoretical and empirical results that are consistent with this argument. We use decimalization as an exogenous shock to liquidity to identify causal effects.

Keywords: Mutual Funds, Risk Shifting, Portfolio Delegation, Stock Illiquidity

JEL Classification: C61, D11, D91, G11, G12, G23

Suggested Citation

Dai, Min and Goncalves-Pinto, Luis and Xu, Jing, How Does Illiquidity Affect Delegated Portfolio Choice? (February 18, 2018). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming, WFA 2010 Victoria Meetings Paper, EFA 2009 Bergen Meetings Paper, Available at SSRN: https://ssrn.com/abstract=1342876 or http://dx.doi.org/10.2139/ssrn.1342876

Min Dai

National University of Singapore ( email )

Singapore

Luis Goncalves-Pinto (Contact Author)

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

HOME PAGE: http://luis.goncalvespinto.com/

Jing Xu

Renmin University of China - School of Finance ( email )

59 Zhongguancun Street
Beijing, 100872
China

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