Hostname: page-component-cd9895bd7-mkpzs Total loading time: 0 Render date: 2024-12-25T20:09:02.206Z Has data issue: false hasContentIssue false
  • English
  • Français

Incentive Contracts and Hedge Fund Management

Published online by Cambridge University Press:  06 April 2009

James E. Hodder  and
Jens Carsten Jackwerth
Get access Rights & Permissions [Opens in a new window]

Abstract

We investigate incentive effects of a typical hedge fund contract for a manager with power utility. With a one-year horizon, the manager displays risk taking that varies dramatically with fund value. We extend the model to multiple yearly evaluation periods and find that the manager's risk taking is rapidly moderated if the fund performs reasonably well. The most realistic approach to modeling fund closure uses an endogenous shutdown barrier where the manager optimally chooses to shut down. The manager increases risk taking as fund value approaches that barrier, and this boundary behavior persists strongly with multiyear horizons.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 4 , December 2007 , pp. 811 - 826
Copyright
Copyright © School of Business Administration, University of Washington 2007

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Basak, S.; Pavlova, A.; and Shapiro, A.. “Optimal Asset Allocation and Risk Shifting in Money Management.” Review of Financial Studies, 20 (2007), 1583–1621.CrossRefGoogle Scholar
Brown, S. J.; Goetzmann, W. N.; and Ibbotson, R. G.. “Offshore Hedge Funds: Survival and Performance, 1989–95.” Journal of Business, 72 (1999), 99–117.Google Scholar
Brown, S. J.; Goetzmann, W. N.; and Park, J.. “Careers and Survival: Competition and Risk in the Hedge Fund and CTA Industry.” Journal of Finance, 61 (2001), 1869–1886.Google Scholar
Carpenter, J. N. “Does Option Compensation Increase Managerial Risk Appetite?’ Journal of Finance, 55 (2000), 2311–2331.CrossRefGoogle Scholar
Fung, W., and Hsieh, D. A.. “A Primer on Hedge Funds.” Journal of Empirical Finance, 6 (1999), 309–331.CrossRefGoogle Scholar
Getmansky, M.; Lo, A. W.; and Mei, S. X.. “Sifting through the Wreckage: Lessons from Recent Hedge-Fund Liquidations.” Journal of Investment Management, 2 (2004), 6–38.Google Scholar
Goetzmann, W. N.; Ingersoll, J. E. Jr, and Ross, S. A.. “High-Water Marks and Hedge Fund Management Contracts.” Journal of Finance, 58 (2003), 1685–1717.CrossRefGoogle Scholar
Hu, P.; Kale, J. R.; and Subramanian, A.. “Fund Flows, Performance, Managerial Career Concerns, and Risk-Taking: Theory and Evidence.” Working Paper, Georgia State University (2005).Google Scholar
Jarvis, D., and Kushner, H.. “Codes for Optimal Stochastic Control.” Documentation and Users Guide, Brown University (1996).Google Scholar
Kushner, H., and Dupuis, P.. Numerical Methods for Stochastic Control Problems in Continuous Time. Berlin and New York: Springer Verlag (1992).CrossRefGoogle Scholar
Markowitz, H.Portfolio Selection: Efficient Diversification of Investments. Cowles Foundation Monograph #16. New York: Wiley (1959) (reprinted by Blackwell 1991).Google Scholar
Merton, R. “Lifetime Portfolio Selection under Uncertainty: The Continuous Time Case.” Review of Economics and Statistics, 51 (1969), 247–257.CrossRefGoogle Scholar
Mossin, J. “Optimal Multiperiod Portfolio Policies.” Journal of Business, 41 (1968), 215–229.Google Scholar
Panageas, S. and Westerfield, M. M.. “High-Water Marks: High Risk Appetites? Convex Compensation, Long Horizons and Portfolio Choice.” Journal of Finance (forthcoming 2008).CrossRefGoogle Scholar
Stuart, A., and Ord, S.. Kendall's Advanced Theory of Statistics, Vol. 1, 5th ed. New York: Oxford University Press (1987).Google Scholar