TY - JOUR
T1 - Does prior performance affect a mutual funds choice of risk? Theory and further empirical evidence
AU - Chen, Hsiu Lang
AU - Pennacchi, George G.
PY - 2009/8
Y1 - 2009/8
N2 - Recent empirical studies of mutual fund competition examine the relation between a funds performance, the fund managers compensation, and the fund managers choice of portfolio risk. This paper models a managers portfolio choice for compensation rules that can be either a concave, linear, or convex function of the funds performance relative to that of a benchmark. For particular compensation structures, a manager increases the funds tracking error volatility as its relative performance declines. However, declining performance does not necessarily lead the manager to raise the volatility of the funds return. The paper presents nonparametric and parametric tests of the relation between mutual fund performance and risk taking for more than 6,000 equity mutual funds over the 1962 to 2006 period. There is a tendency for mutual funds to increase the standard deviation of tracking errors, but not the standard deviation of returns, as their performance declines. This risk-shifting behavior appears more common for funds whose managers have longer tenures.
AB - Recent empirical studies of mutual fund competition examine the relation between a funds performance, the fund managers compensation, and the fund managers choice of portfolio risk. This paper models a managers portfolio choice for compensation rules that can be either a concave, linear, or convex function of the funds performance relative to that of a benchmark. For particular compensation structures, a manager increases the funds tracking error volatility as its relative performance declines. However, declining performance does not necessarily lead the manager to raise the volatility of the funds return. The paper presents nonparametric and parametric tests of the relation between mutual fund performance and risk taking for more than 6,000 equity mutual funds over the 1962 to 2006 period. There is a tendency for mutual funds to increase the standard deviation of tracking errors, but not the standard deviation of returns, as their performance declines. This risk-shifting behavior appears more common for funds whose managers have longer tenures.
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U2 - 10.1017/S002210900999010X
DO - 10.1017/S002210900999010X
M3 - Article
AN - SCOPUS:62149091810
SN - 0022-1090
VL - 44
SP - 745
EP - 775
JO - Journal of Financial and Quantitative Analysis
JF - Journal of Financial and Quantitative Analysis
IS - 4
ER -