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Optimal Investment In Hedge Funds Under Loss Aversion

Author

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  • BIN ZOU

    (Department of Applied Mathematics, University of Washington, Lewis Hall 202, Box 353925, Seattle, Washington 98195-3925, USA)

Abstract

We study optimal investment problems in hedge funds for a loss averse manager under the framework of cumulative prospect theory. We obtain explicit solutions for a general utility function satisfying the Inada conditions and a piece-wise exponential utility function. Through a sensitivity analysis, we find that the manager reduces the risk of the hedge fund when her/his loss aversion, risk aversion, ownership in the fund, or management fee ratio increases. However, the increase of incentive fee ratio drives the manager to seek more risk in order to achieve higher prospect utility.

Suggested Citation

  • Bin Zou, 2017. "Optimal Investment In Hedge Funds Under Loss Aversion," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 20(03), pages 1-32, May.
    • Handle: RePEc:wsi:ijtafx:v:20:y:2017:i:03:n:s0219024917500145
    DOI: 10.1142/S0219024917500145
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    References listed on IDEAS

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    Cited by:

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    2. Lucian Liviu ALBU & Radu LUPU & Adrian Cantemir CĂLIN & Iulia LUPU, 2019. "Nonlinear Modeling of Financial Stability Using Default Probabilities from the Capital Market," Journal for Economic Forecasting, Institute for Economic Forecasting, vol. 0(1), pages 19-37, March.
    3. Constantin Mellios & Anh Ngoc Lai, 2022. "Incentive Fees with a Moving Benchmark and Portfolio Selection under Loss Aversion," Post-Print hal-03708926, HAL.
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    5. Cao, Jingyi & Li, Dongchen & Young, Virginia R. & Zou, Bin, 2023. "Reinsurance games with two reinsurers: Tree versus chain," European Journal of Operational Research, Elsevier, vol. 310(2), pages 928-941.

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