On Tournament Behavior in Hedge Funds: High Water Marks, Managerial Horizon, and the Backfilling Bias

52 Pages Posted: 15 Mar 2010

See all articles by Vikram K. Nanda

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

George O. Aragon

Arizona State University (ASU) - Finance Department

Multiple version iconThere are 2 versions of this paper

Date Written: November 2, 2009

Abstract

We analyze risk shifting by poorly performing hedge funds - and test predictions on the extent to which risk choices are related to the fund's incentive contract, investment horizon and dissemination of performance information. Consistent with theoretical arguments we find that the propensity for losing funds to increase risk is significantly weaker among those that tie the manager's incentive pay to the fund's high-water mark - suggesting a possible benefit from such incentive structures - and among funds that face little immediate risk of closure. "Tournament" behavior is more prevalent in the (backfilled) period when funds may be at an incubation stage. Excluding backfilled data, variance shifts are found to depend more on absolute rather than relative fund performance. Overall, the combination of factors such as high-water mark provisions, low risk of fund closure and the reporting of performance to a database appear to make poorly performing funds more conservative with regard to risk-shifting.

Keywords: hedge funds, tournaments, risk-taking, backfilling, high-water marks

JEL Classification: G11, G12

Suggested Citation

Nanda, Vikram K. and Aragon, George O., On Tournament Behavior in Hedge Funds: High Water Marks, Managerial Horizon, and the Backfilling Bias (November 2, 2009). Available at SSRN: https://ssrn.com/abstract=1570789 or http://dx.doi.org/10.2139/ssrn.1570789

Vikram K. Nanda

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )

2601 North Floyd Road
P.O. Box 830688
Richardson, TX 75083
United States

George O. Aragon (Contact Author)

Arizona State University (ASU) - Finance Department ( email )

W. P. Carey School of Business
PO Box 873906
Tempe, AZ 85287-3906
United States

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