The Prudent Investor Rule and Market Risk: An Empirical Analysis

Journal of Empirical Legal Studies, Volume 14, Issue 1, 129-68, March 2017

Harvard Public Law Working Paper No. 15-06

Northwestern Public Law Research Paper No. 15-16

40 Pages Posted: 25 Mar 2015 Last revised: 27 Mar 2017

Date Written: March 2017

Abstract

The prudent investor rule, enacted in every state over the last 30 years, is the centerpiece of trust investment law. Repudiating the prior law’s emphasis on avoiding risk, the rule reorients trust investment toward risk management in accordance with modern portfolio theory. The rule directs a trustee to implement an overall investment strategy having risk and return objectives reasonably suited to the trust. Using data from reports of bank trust holdings and fiduciary income tax returns, we examine asset allocation and management of market risk before and after the reform. First, we find that the reform increased stockholdings, but not among banks with average trust account sizes below the 25th percentile. This result is consistent with sensitivity in asset allocation to trust risk tolerance. Second, we present evidence consistent with increased portfolio rebalancing after the reform. We conclude that the move toward additional stockholdings was correlated with trust risk tolerance, and that the increased market risk exposure from additional stockholdings was more actively managed.

Keywords: prudent man rule, prudent investor rule, trust investment, fiduciary investment, prudent investor, modern portfolio theory, agency costs, fiduciary, fiduciary duties, risk tolerance, rebalancing, portfolio management

JEL Classification: G11, G28, K11

Suggested Citation

Schanzenbach, Max Matthew and Sitkoff, Robert H., The Prudent Investor Rule and Market Risk: An Empirical Analysis (March 2017). Harvard Public Law Working Paper No. 15-06; Journal of Empirical Legal Studies, Volume 14, Issue 1, 129-68, March 2017; Harvard Public Law Working Paper No. 15-06; Northwestern Public Law Research Paper No. 15-16. Available at SSRN: https://ssrn.com/abstract=2583775 or http://dx.doi.org/10.2139/ssrn.2583775

Max Matthew Schanzenbach

Northwestern University - Pritzker School of Law ( email )

375 E. Chicago Ave
Chicago, IL 60611
United States

Robert H. Sitkoff (Contact Author)

Harvard Law School ( email )

1575 Massachusetts Avenue
Cambridge, MA 02138
United States
(617) 384-8386 (Phone)
(617) 812-6195 (Fax)

HOME PAGE: http://www.law.harvard.edu/faculty/directory/facdir.php?id=649

Register to save articles to
your library

Register

Paper statistics

Downloads
658
Abstract Views
3,027
rank
38,212
PlumX Metrics