Optimal Asset Allocation and Risk Shifting in Money Management

Posted: 7 Aug 2006 Last revised: 21 Mar 2008

See all articles by Anna Pavlova

Anna Pavlova

London Business School; Centre for Economic Policy Research (CEPR)

Suleyman Basak

London Business School; Centre for Economic Policy Research (CEPR)

Alex Shapiro

New York University (NYU) - Department of Finance

Abstract

This paper investigates a fund manager's risk-taking incentives induced by an increasing and convex fund-flows to relative-performance relationship. In a dynamic portfolio choice framework, we show that the ensuing convexities in the manager's objective give rise to a finite risk-shifting range over which she gambles to finish ahead of her benchmark. Such gambling entails either an increase or a decrease in the volatility of the manager's portfolio, depending on her risk tolerance. In the latter case, the manager reduces her holdings of the risky asset despite its positive risk premium. Our empirical analysis lends support to the novel predictions of the model.

Keywords: Fund Flows, Implicit Incentives, Risk Taking, Relative Performance, Risk Management, Portfolio Choice

JEL Classification: G11, G20, D60, D81

Suggested Citation

Pavlova, Anna and Basak, Suleyman and Shapiro, Alex, Optimal Asset Allocation and Risk Shifting in Money Management. Review of Financial Studies, Vol. 20, No. 5, pp. 1583-1621, 2007. Available at SSRN: https://ssrn.com/abstract=922507

Anna Pavlova (Contact Author)

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
+44 20 7000 8218 (Phone)

HOME PAGE: http://faculty.london.edu/apavlova

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Suleyman Basak

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom
44 (0)20 7000 8256 (Phone)
44 (0)20 7000 8201 (Fax)

HOME PAGE: http://www.suleymanbasak.com

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Alex Shapiro

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0362 (Phone)
212-995-4233 (Fax)

HOME PAGE: http://www.stern.nyu.edu/~ashapiro/

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