Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management
Money managers are rewarded for increasing the value of assets under management, and predominantly so in the mutual fund industry. This gives the manager an implicit incentive to exploit the well-documented positive fund-flows to relati...
| Main Authors: | , , |
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| Format: | Working Paper |
| Language: | en_US |
| Published: |
2003
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| Subjects: | |
| Online Access: | http://hdl.handle.net/1721.1/3514 |
| _version_ | 1826199128560893952 |
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| author | Basak, Suleyman Pavlova, Anna Shapiro, Alex |
| author_facet | Basak, Suleyman Pavlova, Anna Shapiro, Alex |
| author_sort | Basak, Suleyman |
| collection | MIT |
| description | Money managers are rewarded for increasing the value of assets under management,
and predominantly so in the mutual fund industry. This gives the manager an implicit
incentive to exploit the well-documented positive fund-flows to relative-performance
relationship by manipulating her risk exposure. In a dynamic asset allocation
framework, we show that as the year-end approaches, the ensuing convexities in the
manager's objective induce her to closely mimic the index, relative to which her
performance is evaluated, when the fund's year-to-date return is sufficiently high. As
her relative performance falls behind, she chooses to deviate from the index by either
increasing or decreasing the volatility of her portfolio. The maximum deviation is
achieved at a critical level of underperformance. It may be optimal for the manager to
reach such deviation via selling the risky asset despite its positive risk premium. Under
multiple sources of risk, with both systematic and idiosyncratic risks present, we show
that optimal managerial risk shifting may not necessarily involve taking on any
idiosyncratic risk. The manager's policy results in economically significant departures
from investors' desired risk exposure. We then demonstrate how constraining the
manager's investment opportunity set, via a simple benchmarking restriction, can
ameliorate the adverse effects of managerial incentive |
| first_indexed | 2024-09-23T11:14:51Z |
| format | Working Paper |
| id | mit-1721.1/3514 |
| institution | Massachusetts Institute of Technology |
| language | en_US |
| last_indexed | 2024-09-23T11:14:51Z |
| publishDate | 2003 |
| record_format | dspace |
| spelling | mit-1721.1/35142019-04-10T23:47:29Z Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management Basak, Suleyman Pavlova, Anna Shapiro, Alex Fund Flows Implicit Incentives Risk Taking Benchmarking Risk Management Investments Money managers are rewarded for increasing the value of assets under management, and predominantly so in the mutual fund industry. This gives the manager an implicit incentive to exploit the well-documented positive fund-flows to relative-performance relationship by manipulating her risk exposure. In a dynamic asset allocation framework, we show that as the year-end approaches, the ensuing convexities in the manager's objective induce her to closely mimic the index, relative to which her performance is evaluated, when the fund's year-to-date return is sufficiently high. As her relative performance falls behind, she chooses to deviate from the index by either increasing or decreasing the volatility of her portfolio. The maximum deviation is achieved at a critical level of underperformance. It may be optimal for the manager to reach such deviation via selling the risky asset despite its positive risk premium. Under multiple sources of risk, with both systematic and idiosyncratic risks present, we show that optimal managerial risk shifting may not necessarily involve taking on any idiosyncratic risk. The manager's policy results in economically significant departures from investors' desired risk exposure. We then demonstrate how constraining the manager's investment opportunity set, via a simple benchmarking restriction, can ameliorate the adverse effects of managerial incentive 2003-05-23T19:25:47Z 2003-05-23T19:25:47Z 2003-05-23T19:25:47Z Working Paper http://hdl.handle.net/1721.1/3514 en_US MIT Sloan School of Management Working Paper;4303-03 421785 bytes application/pdf application/pdf |
| spellingShingle | Fund Flows Implicit Incentives Risk Taking Benchmarking Risk Management Investments Basak, Suleyman Pavlova, Anna Shapiro, Alex Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management |
| title | Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management |
| title_full | Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management |
| title_fullStr | Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management |
| title_full_unstemmed | Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management |
| title_short | Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management |
| title_sort | offsetting the incentives risk shifting and benefits of benchmarking in money management |
| topic | Fund Flows Implicit Incentives Risk Taking Benchmarking Risk Management Investments |
| url | http://hdl.handle.net/1721.1/3514 |
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