Incentive Contracts and Hedge Fund Management

Posted: 28 Mar 2007

See all articles by James E. Hodder

James E. Hodder

Wisconsin School of Business

Jens Carsten Jackwerth

University of Konstanz - Department of Economics

Abstract

We investigate incentive effects of a typical hedge-fund contract for a manager with power utility. With a one-year horizon, she displays risk-taking that varies dramatically with fund value. We extend the model to multiple yearly evaluation periods and find her risk-taking is rapidly moderated if the fund performs reasonably well. The most realistic approach to modeling fund closure uses an endogenous shutdown barrier where the manager optimally chooses to shut down. The manager increases risk-taking as fund value approaches that barrier, and this boundary behavior persists strongly with multiyear horizons.

Suggested Citation

Hodder, James Ernest and Jackwerth, Jens Carsten, Incentive Contracts and Hedge Fund Management. Journal of Financial and Quantitative Analysis, May 2006, Available at SSRN: https://ssrn.com/abstract=970439

James Ernest Hodder (Contact Author)

Wisconsin School of Business ( email )

975 University Avenue
Madison, WI 53706
United States
608-262-8774 (Phone)
608-263-0477 (Fax)

Jens Carsten Jackwerth

University of Konstanz - Department of Economics ( email )

Universitaetsstr. 10
Konstanz, 78457
Germany
+497531882196 (Phone)
+497531883120 (Fax)

HOME PAGE: http://cms.uni-konstanz.de/wiwi/jackwerth/

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