High-Water Marks: High Risk Appetites? Convex Compensation, Long Horizons, and Portfolio Choice
AbstractWe study the portfolio choice of hedge fund managers who are compensated by high-water mark contracts. We find that even risk-neutral managers do not place unbounded weights on risky assets, despite option-like contracts. Instead, they place a constant fraction of funds in a mean-variance efficient portfolio and the rest in the riskless asset, acting as would constant relative risk aversion (CRRA) investors. This result is a direct consequence of the in(de)finite horizon of the contract. We show that the risk-seeking incentives of option-like contracts rely on combining finite horizons and convex compensation schemes rather than on convexity alone. Copyright (c) 2009 The American Finance Association.
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Bibliographic InfoArticle provided by American Finance Association in its journal The Journal of Finance.
Volume (Year): 64 (2009)
Issue (Month): 1 (02)
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