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Optimal investment under high-water mark contracts with model ambiguity

Author

Listed:
  • Wang, Ying
  • Wu, Weixing
  • Huang, Wenli
  • Liu, Wenqiong

Abstract

This paper incorporates the ambiguities of the risky asset and the exogenous shock to explore how the two ambiguities influence the hedge funds model. We find the ambiguity of the risky asset makes the manager more risk averse and invest less. While the ambiguity of the exogenous shock induce the manager adopt radical investment way and invest more. But at the lower and upper bounds, both ambiguities do not work any more. The manager’s total value is eroded by either of the two ambiguities. Although the manager adopts different investment strategies for the two ambiguities, her income makes little difference. In high uncertain context of the external shock or the risky asset, manager’s rigorous investment strategies can protect the values of the investors and the entire fund. Both of the ambiguities have negative influences on the incentive fee and also reduce the proportion of incentive fee in her total income.

Suggested Citation

  • Wang, Ying & Wu, Weixing & Huang, Wenli & Liu, Wenqiong, 2023. "Optimal investment under high-water mark contracts with model ambiguity," The North American Journal of Economics and Finance, Elsevier, vol. 68(C).
    • Handle: RePEc:eee:ecofin:v:68:y:2023:i:c:s1062940823001195
    DOI: 10.1016/j.najef.2023.101996
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    References listed on IDEAS

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    1. Pascal J. Maenhout, 2004. "Robust Portfolio Rules and Asset Pricing," The Review of Financial Studies, Society for Financial Studies, vol. 17(4), pages 951-983.
    2. Luo, Deqing & Wu, Xiaoping & Xu, Jiawen & Yan, Jingzhou, 2022. "Robust leverage decision under locked wealth and high-water mark contract," Finance Research Letters, Elsevier, vol. 46(PB).
    3. Lan, Yingcong & Wang, Neng & Yang, Jinqiang, 2013. "The economics of hedge funds," Journal of Financial Economics, Elsevier, vol. 110(2), pages 300-323.
    4. Christian Kellner, 2017. "The principal-agent problem with smooth ambiguity," Review of Economic Design, Springer;Society for Economic Design, vol. 21(2), pages 83-119, June.
    5. Yuxiang Bian & Xiong Xiong & Jinqiang Yang, 2020. "Leverage and valuation of hedge funds under model uncertainty," The European Journal of Finance, Taylor & Francis Journals, vol. 26(17), pages 1798-1816, November.
    6. Congming Mu & Jingzhou Yan & Jinqiang Yang, 2023. "Robust risk choice under high-water mark contract," Review of Quantitative Finance and Accounting, Springer, vol. 61(1), pages 295-322, July.
    7. Yingjie Niu & Jinqiang Yang & Zhentao Zou, 2019. "Dynamic Agency and Investment Theory under Model Uncertainty," International Review of Finance, International Review of Finance Ltd., vol. 19(2), pages 447-458, June.
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    Cited by:

    1. Lin, Zhenmei & Lai, Chong & Li, Rui, 2025. "Optimal consumption and portfolio selection for retirees under inflation and pension default risk," The North American Journal of Economics and Finance, Elsevier, vol. 79(C).

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    Keywords

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    JEL classification:

    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors

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