Convex Incentives and Liquidity Premia

75 Pages Posted: 21 Dec 2018 Last revised: 16 May 2019

See all articles by Min Dai

Min Dai

National University of Singapore (NUS) - Department of Mathematics

Luis Goncalves-Pinto

Chinese University of Hong Kong - Department of Finance

Jing Xu

Renmin University of China - School of Finance

Cheng Yan

Durham Business School

Date Written: May 15, 2019

Abstract

In the mutual fund industry, managerial contracts are typically incomplete and asymmetric due to convex flows and bonuses. This gives fund managers an incentive to gamble in response to beating their benchmarks. In the presence of transaction costs, gambling is expensive and less effective at capturing flows and bonuses. In equilibrium, fund managers demand high expected stock returns to compensate for the direct and indirect effects of trading costs. We find empirical support for our theoretical results, using the mutual fund scandal of 2003 as an exogenous shock to gambling incentives to identify causal effects.

Keywords: Mutual Funds, Convex Flows, Bonuses, Transaction Costs, Liquidity Premia

JEL Classification: C61, D11, D91, G11

Suggested Citation

Dai, Min and Goncalves-Pinto, Luis and Xu, Jing and Yan, Cheng, Convex Incentives and Liquidity Premia (May 15, 2019). Available at SSRN: https://ssrn.com/abstract=3288875 or http://dx.doi.org/10.2139/ssrn.3288875

Min Dai

National University of Singapore (NUS) - Department of Mathematics ( email )

Singapore

Luis Goncalves-Pinto (Contact Author)

Chinese University of Hong Kong - Department of Finance ( email )

Cheng Yu Tung Building
Shatin
Hong Kong
Hong Kong

Jing Xu

Renmin University of China - School of Finance ( email )

59 Zhongguancun Street
Beijing, 100872
China

Cheng Yan

Durham Business School ( email )

Mill Hill Lane
Durham, Durham DH1 3LB
United Kingdom

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