Convex Incentives and Liquidity Premia

76 Pages Posted: 21 Dec 2018 Last revised: 24 Mar 2020

See all articles by Min Dai

Min Dai

National University of Singapore

Luis Goncalves-Pinto

University of New South Wales (UNSW); Chinese University of Hong Kong (CUHK)

Jing Xu

Renmin University of China - School of Finance

Cheng Yan

Durham Business School

Date Written: March 24, 2020

Abstract

We generate large liquidity premia endogenously from the interaction of transaction costs with convexity in preferences, offering a novel explanation for a longstanding puzzle. We derive this result from the dynamic portfolio problem of mutual fund managers facing either convex flows or year-end bonuses, but we show its robustness to other sources of convexity such as loss aversion or status concerns. We also provide empirical support for the main mechanism in our model, using the mutual fund scandal of 2003 as an exogenous shock to convex 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 (March 24, 2020). Available at SSRN: https://ssrn.com/abstract=3288875 or http://dx.doi.org/10.2139/ssrn.3288875

Min Dai

National University of Singapore ( email )

Singapore

Luis Goncalves-Pinto (Contact Author)

University of New South Wales (UNSW) ( email )

Kensington
High St
Sydney, NSW 2052
Australia

HOME PAGE: http://luis.goncalvespinto.com/

Chinese University of Hong Kong (CUHK) ( 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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