Risk Taking by Mutual Funds as a Response to Incentives

55 Pages Posted: 12 Jul 2000 Last revised: 26 Oct 2022

See all articles by Judith A. Chevalier

Judith A. Chevalier

Yale School of Management; National Bureau of Economic Research (NBER)

Glenn Ellison

Massachusetts Institute of Technology (MIT) - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: August 1995

Abstract

This paper examines the agency conflict between mutual fund investors and mutual fund companies. Investors would like the fund company to use its judgement to maximize risk-adjusted fund returns. A fund company, however, in its desire to maximize its value as a concern has an incentive to take actions which increase the inflow of investment. We use a semiparametric model to estimate the shape of the flow-performance relationship for a sample of growth and growth and income funds observed over the 1982-1992 period. The shape of the flow-performance relationship creates incentives for fund managers to increase or decrease the riskiness of the fund which are dependent on the fund's year-to-date return. Using a new dataset of mutual fund portfolios which includes equity portfolio holdings for September and December of the same year, we show that mutual funds do alter their portfolio riskiness between September and December in a manner consistent with these risk incentives.

Suggested Citation

Chevalier, Judith A. and Ellison, Glenn David, Risk Taking by Mutual Funds as a Response to Incentives (August 1995). NBER Working Paper No. w5234, Available at SSRN: https://ssrn.com/abstract=225298

Judith A. Chevalier (Contact Author)

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Glenn David Ellison

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