Delegated Portfolio Management and Risk Taking Behavior

51 Pages Posted: 18 May 2006 Last revised: 4 Jan 2008

See all articles by Jose L. B. Fernandes

Jose L. B. Fernandes

Universidade de Brasília

Juan Ignacio Peña

Universidad Carlos III de Madrid - Department of Business Administration

Benjamin M. Tabak


Date Written: January 2008


Standard models of moral hazard predict a negative relationship between risk and incentives; however empirical studies on mutual funds present mixed results. In this paper, we propose a behavioral principal-agent model in the context of professional managers, focusing on active and passive investment strategies. Using this general framework, we evaluate how incentives affect the risk taking behavior of managers, using the standard moral hazard model as a special case. Our propositions suggest that managers of passively managed funds tend to be risk averse and tend to be rewarded without incentive fees. On the other hand, in actively managed funds, whether incentives reduce or increase the riskiness of the fund depends on how hard it is to outperform the benchmark. If the fund is likely to outperform the benchmark, incentives reduce the manager's risk appetite. Furthermore, the evaluative horizon influences the trader's risk preferences, in the sense that if traders performed poorly in a period, they tend to choose riskier investments in the following period given the same evaluative horizon. If the fund is unlikely to outperform the benchmark, the opposite is true; incentives cause increased risk taking, and if traders performed well in a given time period, they tend to choose more conservative investments following that time period. Empirical evidence, based on a world sample of 4584 mutual funds, gives support to the previous propositions.

Keywords: Agency Model, Delegated Portfolio Management, Loss Aversion

JEL Classification: M52

Suggested Citation

Fernandes, Jose Luiz Barros and Peña, Juan Ignacio and Tabak, Benjamin M., Delegated Portfolio Management and Risk Taking Behavior (January 2008). Available at SSRN: or

Jose Luiz Barros Fernandes (Contact Author)

Universidade de Brasília ( email )

Campus Universitário Darcy Ribeiro
Brasília, Distrito Federal 70910-900

Juan Ignacio Peña

Universidad Carlos III de Madrid - Department of Business Administration ( email )

Calle Madrid 126
Getafe, Madrid, Madrid 28903
34 91 624 9625 (Phone)
34 91 624 9608 (Fax)

Benjamin M. Tabak

FGV/EPPG ( email )

SGAN Av. L2 Norte - Quadra 602 - Módulos A, B e C
Brasília, Rio de Janeiro 70830-051

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