Incentives and Risk Taking in Hedge Funds
| Dec 14th, 2006 | Filed under: Academic Research, Investment Management Fees | By: Alpha Male |
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By: Roy Kouwenberg, Asian Institute of Technology & Erasmus University, William Ziemba, University of British Columbia
Published: July 2005
Lacking any common definition of the term “hedge fund” many use the moniker to refer to a fund that is a) is “unregulated” and b) involves some kind of unique fee structure such as a performance fee.
So this paper on the effect of management & performance fees on hedge fund risk aversion is particularly salient. The authors studied both single manager funds and funds of funds to determine if the existence of a performance fee might change a manager’s views on volatility, skewedness and kurtosis (as expressed by the performance of their funds).
Kouwenberg & Ziemba draw heavily on “prospect theory“ that states that the decrease in utility from a loss is larger than the utility increase from a commensurate gain. They describe the implication for hedge fund managers the following way:
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