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Compensation incentives and risk taking behavior: evidence from mutual funds

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Author Info
Athanasios Orphanides

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Abstract

This paper examines the role of compensation contracts in determining risk taking decisions by money managers in the financial industry. A methodology is developed for empirically testing and assessing the magnitude of the effect that incentive contracts have on risk taking in the mutual fund industry using paneldata. The methodology exploits the within-year cross sectional variation in the performance of mutual funds to identify systematic time series variation in risk taking. Growth and growth and income mutual funds in the 1976 to 1993 period are examined. The evidence suggests that incentive compensation has substantial influence on risk decisions. A strong seasonal component on average risk is present with risk reaching a peak in the first quarter of the year. However the relationship between within-year performance, especially towards year-end, appears to have changed over time. For losing managers, excess risk taking appears early in the sample but not in later years. For winning managers, reductions in risk taking appears towards year-end in later years but not early in the sample.

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Publisher Info
Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 96-21.

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Date of creation: 1996
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Publication status: Published in Risk measurement and systemic risk: joint central bank research conference (1995: November 16-17)
Handle: RePEc:fip:fedgfe:96-21

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Related research
Keywords: Risk ; Mutual funds ; Income distribution;

References listed on IDEAS
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  1. Athanasios Orphanides & Brian Reid & David H. Small, 1993. "The empirical properties of a monetary aggregates that adds bond and stock funds to M2," Finance and Economics Discussion Series 93-42, Board of Governors of the Federal Reserve System (U.S.).
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  2. Starks, Laura T., 1987. "Performance Incentive Fees: An Agency Theoretic Approach," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 22(01), pages 17-32, March. [Downloadable!]
  3. Goetzmann, W.N., 1993. "Attrition and Mutual Fund Performance," Papers 93-01, Columbia - Graduate School of Business.
  4. Brown, Keith C & Harlow, W V & Starks, Laura T, 1996. " Of Tournaments and Temptations: An Analysis of Managerial Incentives in the Mutual Fund Industry," Journal of Finance, American Finance Association, vol. 51(1), pages 85-110, March. [Downloadable!] (restricted)
  5. 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.
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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Alexander Kempf & Stefan Ruenzi, 2004. "Tournaments in Mutual Fund Families," Finance 0404011, EconWPA. [Downloadable!]
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