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Rewarding Trading Skills Without Inducing Gambling

Author

Listed:
  • Igor Makarov

    (Sloan School of Management)

  • Guillaume Plantin

    (Département d'économie)

Abstract

This paper develops a model of active asset management in which fund managers may forgo alpha-generating strategies, preferring instead to make negative-alpha trades that enable them to temporarily manipulate investors' perceptions of their skills. We show that such trades are optimally generated by taking on hidden tail risk, and are more likely to occur when fund managers are impatient and when their trading skills are scalable, and generate a high profit per unit of risk. We propose long-term contracts that deter this behavior by dynamically adjusting the dates on which the manager is compensated in response to her cumulative performance.

Suggested Citation

  • Igor Makarov & Guillaume Plantin, 2015. "Rewarding Trading Skills Without Inducing Gambling," Sciences Po publications info:hdl:2441/2lk3hracjf8, Sciences Po.
    • Handle: RePEc:spo:wpmain:info:hdl:2441/2lk3hracjf8vip44o7neiujmv7
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    References listed on IDEAS

    as
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