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Mutual fund tournament: risk taking incentives induced by ranking objectives

By Alexei P. Goriaev, Frédéric Palomino and Andrea Prat

Abstract

There is now extensive empirical evidence showing that fund managers have relative performance objectives and adapt their investment strategy in the last part of the calendar year to balance their performance in the early part of the year. Emphasis was, however, put on returns in excess of some exogenous benchmark return. In this Paper, we investigate whether fund managers have ranking objectives (as in a tournament). First, in a two-period model, we analyse the game played by two risk-neutral fund managers with ranking objectives. We show that ranking objectives provide incentives for an interim loser to increase risk in the last part of the year. In the second part of the Paper, we test some predictions of the model. We find evidence that funds ranked in the top decile after the first part of the year have risk incentives generated by ranking objectives and that risk induced by ranking objectives is mainly systematic

Topics: HG Finance
Publisher: Centre for Economic Policy Research
Year: 2001
OAI identifier: oai:eprints.lse.ac.uk:5217
Provided by: LSE Research Online
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