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

44 Pages Posted: 22 Nov 2010

See all articles by Suleyman Basak

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: October 2010

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: mutual fund tournament, portfolio choice, relative performance, risk-taking incentives, short-sale constraints

JEL Classification: D81, G11

Suggested Citation

Basak, Suleyman and Makarov, Dmitry, Difference in Interim Performance and Risk Taking with Short-Sale Constraints (October 2010). CEPR Discussion Paper No. DP8072. Available at SSRN: https://ssrn.com/abstract=1711085

Suleyman Basak (Contact Author)

London Business School ( email )

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HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Dmitry Makarov

ICEF, Higher School of Economics ( email )

26 Shabolovka
Moscow
Russia

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

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