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How Are Derivatives Used? Evidence from the Mutual Fund Industry

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  • Jennifer Lynch Koski

    (School of Business Administration, University of Washington)

  • Jeffrey Pontiff

    (School of Business Administration, University of Washington)

Abstract

We investigate investment managers' use of derivatives by comparing return distributions for equity mutual funds that use and do not use derivatives. In contrast to public perception, derivative users have risk exposure and return performance that are similar to nonusers. We also analyze changes in fund risk in response to prior fund performance. Changes in risk are substantially less severe for funds using derivatives, consistent with the explanation that managers use derivatives to reduce the impact of performance on risk. We provide new evidence regarding the implications of cash flows and managerial gaming for the relation between performance and risk. Copyright The American Finance Association 1999.

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Bibliographic Info

Article provided by American Finance Association in its journal The Journal of Finance.

Volume (Year): 54 (1999)
Issue (Month): 2 (04)
Pages: 791-816

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Handle: RePEc:bla:jfinan:v:54:y:1999:i:2:p:791-816

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References

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  1. Mark Grinblatt & Sheridan Titman, 1989. "Adverse Risk Incentives and the Design of Performance-Based Contracts," Management Science, INFORMS, vol. 35(7), pages 807-822, July.
  2. Mark Grinblatt & Sheridan Titman, . "Adverse Risk Incentives and the Design of Performance-Based Contracts," Rodney L. White Center for Financial Research Working Papers 21-88, Wharton School Rodney L. White Center for Financial Research.
  3. Robert C. Merton, 1995. "Financial Innovation and the Management and Regulation of Financial Institutions," NBER Working Papers 5096, National Bureau of Economic Research, Inc.
  4. Ippolito, Richard A, 1992. "Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry," Journal of Law and Economics, University of Chicago Press, vol. 35(1), pages 45-70, April.
  5. Shanken, Jay, 1990. "Intertemporal asset pricing : An Empirical Investigation," Journal of Econometrics, Elsevier, vol. 45(1-2), pages 99-120.
  6. Chevalier, J. & Ellison, G., 1996. "Risk Taking by Mutual Funds as a Response to Incentives," Working papers 96-3, Massachusetts Institute of Technology (MIT), Department of Economics.
  7. Gary Gorton & Richard Rosen, 1995. "Banks and Derivatives," NBER Working Papers 5100, National Bureau of Economic Research, Inc.
    • Gary Gorton & Richard Rosen, 1995. "Banks and Derivatives," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 299-349 National Bureau of Economic Research, Inc.
  8. Bookstaber, Richard & Clarke, Roger, 1984. "Option Portfolio Strategies: Measurement and Evaluation," The Journal of Business, University of Chicago Press, vol. 57(4), pages 469-92, October.
  9. S. James Press, 1967. "A Compound Events Model for Security Prices," The Journal of Business, University of Chicago Press, vol. 40, pages 317.
  10. Merton, Robert C & Scholes, Myron S & Gladstein, Mathew L, 1978. "The Returns and Risk of Alternative Call Option Portfolio Investment Strategies," The Journal of Business, University of Chicago Press, vol. 51(2), pages 183-242, April.
  11. Pontiff, Jeffrey, 1995. "Closed-end fund premia and returns Implications for financial market equilibrium," Journal of Financial Economics, Elsevier, vol. 37(3), pages 341-370, March.
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