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Optimal Asset Allocation and Risk Shifting in Money Management

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  • Suleyman Basak
  • Anna Pavlova
  • Alexander Shapiro

Abstract

This article investigates a fund manager's risk-taking incentives induced by an increasing and convex relationship of fund flows to relative performance. In a dynamic portfolio choice framework, we show that the ensuing convexities in the manager's objective give rise to a finite risk-shifting range over which she gambles to finish ahead of her benchmark. Such gambling entails either an increase or a decrease in the volatility of the manager's portfolio, depending on her risk tolerance. In the latter case, the manager reduces her holdings of the risky asset despite its positive risk premium. Our empirical analysis lends support to the novel predictions of the model. , Oxford University Press.

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File URL: http://hdl.handle.net/10.1093/rfs/hhm026
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Bibliographic Info

Article provided by Society for Financial Studies in its journal Review of Financial Studies.

Volume (Year): 20 (2007)
Issue (Month): 5 (2007 21)
Pages: 1583-1621

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Handle: RePEc:oup:rfinst:v:20:y:2007:i:5:p:1583-1621

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  1. Alex Shapiro & Suleyman Basak & Anna Pavlova, 2004. "Offsetting the Incentives: Risk Shifting and Benefits of Benchmarking in Money Management," Econometric Society 2004 North American Winter Meetings 583, Econometric Society.
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