High-Water Marks and Hedge Fund Management Contracts with Partial Information

26 Pages Posted: 12 Jan 2012 Last revised: 14 May 2012

See all articles by Dandan Song

Dandan Song

Hunan University - School of Finance and Statistics

Jinqiang Yang

Shanghai University of Finance and Economics

Zhaojun Yang

Southern University of Science and Technology - Department of Finance

Date Written: January 11, 2012

Abstract

This paper extends the Goetzmann, Ingersoll, and Ross (2003) model to the case of partial information, where the expected return of a hedge fund is not observable but known to be either high or low. The fund manager can dynamically update his belief about the true value of the expected return based on the realization of the net asset value of the hedge fund. Our main purpose is to study the impact of the uncertainty of the expected return on the pricing of the fund manager's various fees and the investor's claim. The results show that partial information has significant impact on the values of the fees and the claim. Specifically, a non-updating fund manager always underestimate the values, and more often than not, the amount underestimated is very significant. The closer the net asset value gets to the high-water mark or the larger the uncertainty of the expected return is, the bigger the amount underestimated will be.

Keywords: high-water mark, hedge fund, performance fee, partial information

JEL Classification: G11, G31, E2

Suggested Citation

Song, Dandan and Yang, Jinqiang and Yang, Zhaojun, High-Water Marks and Hedge Fund Management Contracts with Partial Information (January 11, 2012). Available at SSRN: https://ssrn.com/abstract=1983698 or http://dx.doi.org/10.2139/ssrn.1983698

Dandan Song

Hunan University - School of Finance and Statistics ( email )

School of Finance and Statistics
Changsha, CA 410079
China

Jinqiang Yang

Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Zhaojun Yang (Contact Author)

Southern University of Science and Technology - Department of Finance ( email )

No 1088, Xueyuan Rd.
District of Nanshan
Shenzhen, Guangdong 518055
China

HOME PAGE: http://faculty.sustc.edu.cn/profiles/yangzj

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