78 Pages Posted: 16 Feb 2009 Last revised: 8 Nov 2016
Date Written: November 8, 2016
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 as risk-shifting tools 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: Suggested Citation
Dai, Min and Goncalves-Pinto, Luis and Xu, Jing, How Does Illiquidity Affect Delegated Portfolio Choice? (November 8, 2016). 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