Cautious Risk-Takers: Investor Preferences and Demand for Active Management

63 Pages Posted: 21 Mar 2012 Last revised: 15 Dec 2012

See all articles by Valery Polkovnichenko

Valery Polkovnichenko

Federal Reserve Board - Divison of Research and Statistics

Kelsey D. Wei

University of Texas at Dallas

Feng Zhao

University of Texas at Dallas - Jindal School of Management

Date Written: Novermber 2012

Abstract

Actively managed mutual funds have distinct return distributions from their passive benchmarks and our theoretical analysis using tail-sensitive risk preferences suggests that active value and growth funds may serve to reduce downside risk and capture upside potential, respectively. Furthermore, tail-sensitivity measures estimated from the empirical pricing kernel have significant explanatory power for active fund flows, even after controlling for business cycles and market-wide sentiment. Finally, active funds, unlike their passive counterparts, have exposures to option strategies hedging downside risk or capturing upside potential.

Keywords: tail-sensitive preferences, probability weighting function, active management, mutual funds

JEL Classification: G11, G23

Suggested Citation

Polkovnichenko, Valery and Wei, Kelsey D. and Zhao, Feng, Cautious Risk-Takers: Investor Preferences and Demand for Active Management (Novermber 2012). Available at SSRN: https://ssrn.com/abstract=2022416 or http://dx.doi.org/10.2139/ssrn.2022416

Valery Polkovnichenko (Contact Author)

Federal Reserve Board - Divison of Research and Statistics ( email )

20th and C Streets, NW
Washington, DC 20551
United States

Kelsey D. Wei

University of Texas at Dallas ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States
9728835978 (Phone)

Feng Zhao

University of Texas at Dallas - Jindal School of Management ( email )

800 W. Campbell Rd. SM 31
Richardson, TX 75080
United States
972-883-5815 (Phone)

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