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How Are Derivatives Used? Evidence from the Mutual Fund Industry

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Author Info
Jennifer Koski
Jeffrey Pontiff

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Abstract

Approximately 20 percent of the 675 equity mutual funds analyzed in this paper invest in derivatives. We compare the return distributions of equity mutual funds that invest in derivatives to those that do not. We also analyze the use of derivatives to affect intertemporal changes in fund risk. Equity mutual funds that invest in derivatives have similar risk and similar net return performance in those that do not. Change in fund risk is negatively related to past performance, but derivatives allow funds to dampen these changes. We interpret these results as consistent with the hypothesis that managers are slow to respond to unexpected cash flows, and inconsistent with gaming of incentive compensation systems.

This paper was presented at the Financial Institutions Center's May 1996 conference on "

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Paper provided by Wharton School Center for Financial Institutions, University of Pennsylvania in its series Center for Financial Institutions Working Papers with number 96-27.

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Date of creation: May 1996
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Handle: RePEc:wop:pennin:96-27

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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. Judith A. Chevalier & Glenn D. Ellison, 1995. "Risk Taking by Mutual Funds as a Response to Incentives," NBER Working Papers 5234, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Gary Gorton & Richard Rosen, 1995. "Banks and Derivatives," NBER Chapters, in: NBER Macroeconomics Annual 1995, Volume 10, pages 299-349 National Bureau of Economic Research, Inc. [Downloadable!]
  3. Gary Gorton & Richard Rosen, 1995. "Banks and Derivatives," Center for Financial Institutions Working Papers 95-07, Wharton School Center for Financial Institutions, University of Pennsylvania.
  4. Gary Gorton & Richard Rosen, 1995. "Banks and derivatives," Working Papers 95-12, Federal Reserve Bank of Philadelphia.
  5. Merton, Robert C., 1995. "Financial innovation and the management and regulation of financial institutions," Journal of Banking & Finance, Elsevier, vol. 19(3-4), pages 461-481, June. [Downloadable!] (restricted)
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  6. Gary Gorton & Richard Rosen, . "Banks and Derivatives," Rodney L. White Center for Financial Research Working Papers 06-95, Wharton School Rodney L. White Center for Financial Research.
  7. S. James Press, 1967. "A Compound Events Model for Security Prices," Journal of Business, University of Chicago Press, vol. 40, pages 317. [Downloadable!]
  8. Merton, Robert C & Scholes, Myron S & Gladstein, Mathew L, 1978. "The Returns and Risk of Alternative Call Option Portfolio Investment Strategies," Journal of Business, University of Chicago Press, vol. 51(2), pages 183-242, April. [Downloadable!] (restricted)
  9. Bookstaber, Richard & Clarke, Roger, 1984. "Option Portfolio Strategies: Measurement and Evaluation," Journal of Business, University of Chicago Press, vol. 57(4), pages 469-92, October. [Downloadable!] (restricted)
  10. Gary Gorton & Richard Rosen, . "Banks and Derivatives," Rodney L. White Center for Financial Research Working Papers 6-95, Wharton School Rodney L. White Center for Financial Research.
  11. Gary Gorton & Richard Rosen, 1995. "Banks and Derivatives," NBER Working Papers 5100, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  12. Ippolito, Richard A, 1992. "Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry," Journal of Law & Economics, University of Chicago Press, vol. 35(1), pages 45-70, April.
  13. Pontiff, Jeffrey, 1995. "Closed-end fund premia and returns Implications for financial market equilibrium," Journal of Financial Economics, Elsevier, vol. 37(3), pages 341-370, March. [Downloadable!] (restricted)
  14. 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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