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Difference in Interim Performance and Risk Taking with Short-sale Constraints

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  • Suleyman Basak

    ()
    (London Business School and CEPR)

  • Dmitry Makarov

    ()
    (New Economic School)

Abstract

Absent much theory, empirical works often rely on the following informal reasoning when looking for evidence of a mutual fund tournament: If there is a tournament, interim winners have incentives to decrease their portfolio volatility as they attempt to protect their lead, while interim losers are expected to increase their volatility so as to catch up with winners. We consider a rational model of a mutual fund tournament in the presence of short-sale constraints and find the opposite – interim winners choose more volatile portfolios in equilibrium than interim losers. Several empirical works present evidence consistent with our model, however based on the above informal argument they appear to conclude against the tournament behavior. We argue that this conclusion is unwarranted. We also demonstrate that tournament incentives lead to differences in interim performance for otherwise identical managers, and that mid-year trading volume is inversely related to mid-year stock return.

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Bibliographic Info

Paper provided by Center for Economic and Financial Research (CEFIR) in its series Working Papers with number w0159.

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Length: 43 pages
Date of creation: Oct 2010
Date of revision:
Handle: RePEc:cfr:cefirw:w0159

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Keywords: mutual fund tournament; risk-taking incentives; relative performance; portfolio choice; short-sale constraints;

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References

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Citations

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Cited by:
  1. Pütz, Alexander & Ruenzi, Stefan, 2010. "Overconfidence among professional investors: Evidence from mutual fund managers," CFR Working Papers 08-08 [rev.], University of Cologne, Centre for Financial Research (CFR).
  2. Huang, Shiyang & Qiu, Zhigang & Shang, Qi & Tang, Ke, 2013. "Asset pricing with heterogeneous beliefs and relative performance," Journal of Banking & Finance, Elsevier, Elsevier, vol. 37(11), pages 4107-4119.
  3. Spiegel, Matthew & Zhang, Hong, 2013. "Mutual fund risk and market share-adjusted fund flows," Journal of Financial Economics, Elsevier, Elsevier, vol. 108(2), pages 506-528.
  4. Darren Duxbury & Robert Hudson & Kevin Keasey & Zhishu Yang & Songyao Yao, 2013. "How prior realized outcomes affect portfolio decisions," Review of Quantitative Finance and Accounting, Springer, Springer, vol. 41(4), pages 611-629, November.
  5. Antonio Scalia & Benjamin Sahel, 2012. "Ranking, risk-taking and effort: an analysis of the ECB's foreign reserves management," Temi di discussione (Economic working papers), Bank of Italy, Economic Research and International Relations Area 840, Bank of Italy, Economic Research and International Relations Area.

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