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Ranking, risk-taking and effort: an analysis of the ECB's foreign reserves management

  • Antonio Scalia

    ()

    (Bank of Italy)

  • Benjamin Sahel

    ()

    (European Central Bank)

The investment of the ECB reserves in US dollars and yen involves an annual performance assessment of portfolio managers, located in the Eurosystem�s national central banks. Employing new data on individual portfolios during 2002-2009, we study this peculiar tournament and show the existence of risk-shifting behaviour by reserve managers related to their year-to-date ranking: interim losers increase relative risk in the second half of the year, in the same way as mutual fund managers. In the dollar case the adjustment to ranking is reduced or offset if reserve managers have achieved a positive interim performance against the benchmark. Yen reserve managers that rank low show a tendency to increase effort, as proxied by portfolio turnover. Those who ranked low in the previous year tend to reduce risk significantly. Since reserve managers should have a comparative advantage over the benchmark within a monthly horizon, possible enhancements to the design of the tournament might involve an increased reward for effort and performance by means of a convex scoring system linked to monthly, rather than annual, performance.

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Paper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 840.

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Date of creation: Jan 2012
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Handle: RePEc:bdi:wptemi:td_840_12
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  1. Kempf, Alexander & Ruenzi, Stefan, 2004. "Tournaments in mutual fund families," CFR Working Papers 04-02, University of Cologne, Centre for Financial Research (CFR).
  2. Suleyman Basak & Anna Pavlova & Alexander Shapiro, 2007. "Optimal Asset Allocation and Risk Shifting in Money Management," Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1583-1621, 2007 21.
  3. Basak, Suleyman & Makarov, Dmitry, 2010. "Difference in Interim Performance and Risk Taking with Short-Sale Constraints," CEPR Discussion Papers 8072, C.E.P.R. Discussion Papers.
  4. Goriaev, A.P. & Palomino, F.A. & Prat, A., 2000. "Mutual Fund Tournament : Risk Taking Incentives Induced by Ranking Objectives," Discussion Paper 2000-94, Tilburg University, Center for Economic Research.
  5. Ronald G. Ehrenberg & Michael L. Bognanno, 1988. "Do Tournaments Have Incentive Effects?," NBER Working Papers 2638, National Bureau of Economic Research, Inc.
  6. Jennifer Koski & Jeffrey Pontiff, 1996. "How Are Derivatives Used? Evidence from the Mutual Fund Industry," Center for Financial Institutions Working Papers 96-27, Wharton School Center for Financial Institutions, University of Pennsylvania.
  7. Kempf, Alexander & Ruenzi, Stefan & Thiele, Tanja, 2009. "Employment risk, compensation incentives, and managerial risk taking: Evidence from the mutual fund industry," Journal of Financial Economics, Elsevier, vol. 92(1), pages 92-108, April.
  8. Florian Ederer, 2010. "Feedback and Motivation in Dynamic Tournaments," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 19(3), pages 733-769, 09.
  9. Livio Stracca, 2006. "Delegated Portfolio Management: A Survey Of The Theoretical Literature," Journal of Economic Surveys, Wiley Blackwell, vol. 20(5), pages 823-848, December.
  10. Jennifer Huang & Clemens Sialm & Hanjiang Zhang, 2011. "Risk Shifting and Mutual Fund Performance," Review of Financial Studies, Society for Financial Studies, vol. 24(8), pages 2575-2616.
  11. Goriaev, Alexei & Nijman, Theo E. & Werker, Bas J. M., 2005. "Yet another look at mutual fund tournaments," Journal of Empirical Finance, Elsevier, vol. 12(1), pages 127-137, January.
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