Working Paper: CEPR ID: DP2794
Authors: Alexei Goriaev; Frederic Palomino; 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. However, emphasis was 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.
Keywords: interim performance; ranking-based objectives; risktaking incentives
JEL Codes: G11; G24
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| interim loser (Y20) | increase risk (D81) |
| interim winner (Y60) | decrease risk (G52) |
| ranking objectives (L21) | incentives for interim loser to increase risk (D81) |
| ranking objectives (L21) | incentives for interim winner to decrease risk (D81) |
| interim performance (Y20) | risk levels chosen by managers (D81) |
| top decile ranking (C46) | risk incentives (G22) |