the realization effect risk taking after realized versus paper losses abstract understanding how prior outcomes affect risk attitudes is critical for the study of choice under uncertainty a large literature documents the significant influence of prior losses on risk attitudes the findings appear contradictory some studies find greater risk taking after a loss whereas others show the opposite that people take on less risk i reconcile these seemingly inconsistent findings by distinguishing between realized versus paper losses using new and existing data i replicate prior findings and demonstrate that following a realized loss individuals avoid risk if the same loss is not realized a paper loss individuals take on greater risk jel d11 d14 d81 g11

the possibility of informationally efficient markets abstract a rational expectations equilibrium with positive demand for financial information does exist under fully revealing asset price contrary to a wide held conjecture whereas a continuum of investors is inconsistent with fully revealing equilibrium finitely many investors with average portfolios demand information in equilibrium if they can adjust portfolio size in an additive signal return model more information diminishes the expected excess return of a risky asset so that investors who only have a choice of portfolio composition or whose asset endowments strongly differ from the average portfolio are worse off under fully revealing price information market equilibria both with and without information acquisition are pareto efficient

game shows and economic behavior risk taking on card sharks this paper studies individual risk taking behavior with a unique data set risky decisions of contestants during the threeyear history of the television game show card sharks in the bonus round of the game individuals choose how much to wager on positive expected value gambles with known and varying probabilities and large possible payouts since no special skills or knowledge are involved empirical analysis is not complicated by a contestant s superior information about her own abilities stakes can reach 16 000 and average 3 200 few experimental budgets permit even one observation of this magnitude first i simply estimate how risk averse contestants behave under the assumption of expected utility maximization i estimate a lower bound for the coefficient of absolute risk aversion of 0 00031 which when multiplied by per capita u s personal income gives an estimate of relative risk aversion of 4 8 this estimate is higher than most econometric estimates of risk aversion contestants however do not act in a manner consistent with expected utility maximization so this number should not be given a structural interpretation rather it is simply a useful way to summarize average willingness to bear risk of individuals on the show second i explore how individual behavior is inconsistent with expected utility theory the amount a contestant wishes to wager depends critically on the amount of wealth she has accumulated in the bonus round and therefore on the size of the stakes this is at odds with expected utility theory since the size of the stakes although far from insignificant is small relative to a person s wealth contestants should then have close to constant absolute risk aversion with respect to accumulated winnings in the game a more striking result deals with contestants who had previ

delegated portfolio management abstract a problem of screening agents with privately known forecasting abilities and reservation utilities and then eliciting truthful information from these agents once they are employed is considered for the case of risk averse agents and large principals an approximately optimal solution is constructively characterized under the assumption that payoffs are normally distributed a significant extension of the definnetti savage probability elicitation result is developed under this extension knowledge of agent preferences is not required when the underlying conditional distributions are symmetric and this fact is exploited to solve the screening problem in a mean variance formulation

how to identify trust and reciprocity this paper uses a three games or triadic design to identify trusting and reciprocating behavior a large literature on single game trust and reciprocity experiments is based on the implicit assumption that subjects do not have altruistic or inequality averse other regarding preferences such experimental designs test compound hypotheses that include the hypothesis that other regarding preferences do not affect behavior in contrast experiments with the triadic design do discriminate between transfers resulting from trust or reciprocity and transfers resulting from other regarding preferences that are not conditional on the behavior of others decomposing trust from altruism and reciprocity from altruism or inequality aversion is critical to obtaining empirical information that can guide the process of constructing models that can increase the empirical validity of game theory

the incidence and allocation effects of a tax on corporate distributions abstract to study the effects of double taxation first at the corporation level then at the shareholder level this paper analyzes a model with a tax on all corporate distributions to equity owners and no other taxes contrary to the common view the tax is shown to have no subtitution effect and in particular no effect on the corporate choice between debt and equity via retained earnings finance the analysis opens to question certain arguments commonly used to support integration of corporation and individual income taxes via dividend relief

optimal asset allocation and risk shifting in money management this article investigates a fund manager s risk taking incentives induced by an increasing and convex relationship of fund flows to relative performance in a dynamic portfolio choice framework we show that the ensuing convexities in the manager s objective give rise to a finite risk shifting range over which she gambles to finish ahead of her benchmark such gambling entails either an increase or a decrease in the volatility of the manager s portfolio depending on her risk tolerance in the latter case the manager reduces her holdings of the risky asset despite its positive risk premium our empirical analysis lends support to the novel predictions of the model

moral hazard and the portfolio management problem this paper investigates the significance of nonlinear contracts on the incentive for portfolio managers to collect information in addition the manager must be motivated to disclose this information truthfully we analyze three contracting regimes 1 first best where effort is observable 2 linear with unobservable effort and 3 the optimal contract within the bhattacharya pfleiderer quadratic class we find that the linear contract leads to a serious lack of effort expenditure by the manager this underinvestment problem can be successfully overcome through the use of quadratic contracts these contracts are shown to be asymptotically optimal for very risk tolerant principals

more is better but fair is fair tipping in dictator and ultimatum games abstract this paper examines allocators willingness to reward and punish their paired recipients recipients only compete in a skill testing contest the outcome of which determines the size of the surplus in the dictator game allocators reward skillful recipients but punish unskillful ones only modestly the punishment effect is mitigated by the belief held by some allocators that effort is the appropriate measure of deservingness the ultimatum game extension reveals offerers ability to adapt to the strategic environment offers to skillful recipients in the ultimatum game however are shown to be motivated by a taste for fairness and not strategic considerations journal of economic literature classification numbers c70 c91 d63

optimal vs traditional securities under moral hazard this paper provides an explanation for the widespread use of traditional securities by wellestablished firms standard moral hazard models predict that equity debt and warrants are almost never optimal financing instruments i show that issuing these securities is nevertheless nearly optimal the issuer would gain very little by using non traditional securities instead combined with equity one debt issue without multiple layers of seniority and one warrant issue without multiple exercise prices suffice to achieve near optimality the near optimality of traditional financing depends crucially on the issuer s ability to use war rants in addition to debt and equity

gordon tullock and experimental economics gordon tullock s research has substantially influenced the development of economic science in general and experimental economics in particular we present the first comprehensive survey of this significant achievement we show how tullock s research in bioeconomics influenced later developments in neuroeconomics and how his pioneering work on rent seeking generated a literature of laboratory tests of his hypothesis we also describe tullock s own experiments and draw attention to his early insights on trust games

prospect theory for stock markets empirical evidence with time series data abstract based on the loss aversion model of asset pricing this paper explores empirical evidence on the prospect theory for stock markets with time series data the analysis using a state space model shows that previous gains and losses may have asymmetric effects on investment behavior pointing to the possibility of break even effects ignored by asset pricing models using prospect theory

up close and personal investor sophistication and the disposition effect this paper analyzes the trading records of a major discount brokerage house to investigate the disposition effect the tendency to sell stocks that have appreciated in price winners sooner than stocks that trade below the purchase price losers in contrast to previous research that has demonstrated the disposition effect by aggregating across investors our main objective is to identify differences in the disposition bias across individuals and explain this in terms of underlying investor characteristics building on the findings in experimental economics and social psychology we hypothesize that differences in investor literacy about financial markets and trading frequency are responsible in part for the variation in individual disposition effect using demographic and socioeconomic variables as proxies for investor literacy we find empirical evidence that wealthier individuals and individuals employed in professional occupations exhibit a lower disposition effect consistent with experimental economics trading frequency also tends to reduce the disposition effect we provide guidelines for investment advisors regulators and investment communities to utilize our findings and help investors make better decisions

how do prior gains and losses affect subsequent risk taking new evidence from individual level horse race bets many empirical studies focusing on how prior outcomes affect subsequent risk taking report conclusions that appear mutually contradictory while some studies document increased risk taking after gains and risk aversion after losses others report the opposite this paper contributes to this literature by investigating horse race bettors sequential risky decisions using individual level data a horse race betting market is a laboratory like environment and can be used to analyze behavioral patterns associated with decision making under risk we find evidence for i the house money effect as bettors take riskier wagers after gains and mostly spend the money they have won ii risk aversion after prior losses which we label a playing safe effect and iii a preference for breakeven contrary to the widely held conception in the empirical literature our findings suggest that the break even effect does not necessarily imply an increased preference for riskier bets because bettors may seek to break

reservation wage and optimal contract for experts abstract we examine the optimal contract for experts with type dependent reservation wage we show that bhattacharya and pfleiderer 1985 s result the possibility of achieving the truthful revelation of information with full surplus extraction can be achieved with relaxing the restriction on the shape of reservation wage schedules this outcome can be achieved through payoff functions that are affine in a convex transformation of the ex post error our result is applied to the case of multiple experts

on the political economy of uk pension scheme regulation we take the opportunity of the recent consultation exercise on uk defined benefit pension schemes conducted by the pensions regulator to examine the approach to pension scheme portfolio management that it and the related pension protection fund have adopted after summarising the regulatory basis we identify three essential building blocks for further examination the notion of matching liabilities to long term government bonds the use of standard deviation of return as a measure of risk and the idea that strategic asset allocation is the most important decision in portfolio management this last one the brinson axiom we examine these foundations individually and then collectively with the aid of two unobtrusive postulates the first being the efficient markets hypothesis and the second that pension scheme assets should be used to purchase only those securities with minimal default risk from the perspective of what we have elsewhere called the keynes graham schema we conclude that the foundations are unsound and that the conventional approach adopted not only by both the regulator and the protection fund but also by the major actuarial consultancies induces if not actually requires pension schemes to engage in speculation rather than investment

revisiting the house money effect in the field evidence from casino jackpots abstract this paper tests the house money effect i e that prior gains increase subsequent risk taking behavior in the field we use individual level slot machine gambling records of 5 169 players from a real casino and employ jackpot hits as exogenous house money shocks our results show that players wager significantly less money after hitting a jackpot which implies that players reduce their risk taking behavior and thus act more cautiously after experiencing gains we fail to replicate the house money effect in the field and find evidence for a reverse house money effect furthermore while risk taking behavior is reduced after hitting a jackpot the jackpot size has no additional effect

relative performance of incentive mechanisms computational modeling and simulation of delegated investment decisions this paper evaluates the relative performances of several well known and widely used incentive mechanisms under controlled experimental conditions the scenario utilized is a delegated investment setting where effort and risk aversions contribute to moral hazard among fund managers analytical intractability of the problem requires a computational modeling approach to simulate comparative solutions for specific contracts under different parametric settings through a simulation exercise we consider multiple agents who decide their investment strategy over several consecutive periods agents learn about estimation and market uncertainty through repeated realizations of investment returns in each sequence of periods a number of different incentive mechanisms based on the agent s communication and or outcome are considered results of the computational experiments are presented our results overwhelmingly show the efficacy of the incentive contracts in improving the welfare of the investors in the presence of an estimation risk when agents learn from their past performances the market volatility interacts with the estimation risk that makes risk sharing arrangements such as limited liability overly important paying the agent to assume the risk may no longer lead to the best performance incentives

on the incentives for money managers abstract money managers select weights of managed portfolios to enhance their reputation in the spot market for their services inevitably using their actions to signal their quality we develop a two asset signalling model of money managers a unique screening equilibrium and under certain parameter configurations a host of pooling equilibria survive the cho kreps intuitive criterion in all the equilibria managers behave more aggressively than they would in the absence of the signalling motive exaggerating their position in the risky asset

direct sale of information when precision is unobservable this paper studies the incentives of an information seller to produce precise information in a setting where precision is not observable and investors with rational expectations can extract information from the equilibrium asset price i show that the seller can verify her unknown precision by employing a nonlinear contract proposed by bhattacharya and p eiderer 1985 although precision is not observable buyers can perfectly deduce it from the contract apart from incentives to produce precise information and reveal it truthfully the nonlinear contract also insures against the portfolio risk of information buyers and causes them to trade aggressively for a given precision this increases the extent of information that is built into the equilibrium asset price the seller s equilibrium fee depends on i her inferred precision ii the value of portfolio insurance for buyers and iii the extent of information that leaks from the equilibrium asset price

an econometric model of serial correlation and illiquidity in hedge fund returns the returns to hedge funds and other alternative investments are often highly serially correlated in sharp contrast to the returns of more traditional investment vehicles such as long only equity portfolios and mutual funds in this paper we explore several sources of such serial correlation and show that the most likely explanation is illiquidity exposure i e investments in securities that are not actively traded and for which market prices are not always readily available for portfolios of illiquid securities reported returns will tend to be smoother than true economic returns which will understate volatility and increase risk adjusted performance measures such as the sharpe ratio we propose an econometric model of illiquidity exposure and develop estimators for the smoothing prole as well as a smoothing adjusted sharpe ratio for a sample of 908 hedge funds drawn from the tass database we show that our estimated smoothing coecien ts vary considerably across hedge fund style categories and may be a useful proxy for quantifying illiquidity exposure

delegated portfolio management a survey of the theoretical literature abstract this paper provides a selective review of the theoretical literature on delegated portfolio management as a principal agent relationship the main focus of the paper is to review the analytical issues raised by the peculiar nature of the delegated portfolio management relationship within the broader class of principal agent models in particular the paper discusses the performance of linear versus nonlinear compensation contracts in a single period setting the possible effects of limited liability of portfolio managers the role of reputational concerns in a multiperiod framework and the incentives to noise trading in addition the paper deals with some general equilibrium dimensions and asset pricing implications of delegated portfolio management the paper also suggests some directions for future research

brokerage commission schedules it is generally optimal for risk sharing reasons to base a charge for information on the signal realization when this is not possible a charge based on the amount of trading a brokerage commission may be a good alternative the optimal brokerage commission schedule is derived for a risk neutral information seller faced with risk averse purchasers who may differ in their risk aversion revenues from the brokerage commission are compared with those from a fixed charge for information and the optimal mutual fund management fee the brokerage industry is a significant source of information for investors about prospective security returns one indication of this is that of the 11 817 members of the association for investment management and research who listed their occupations as investment management or research in 1991 21 percent worked for brokers and investment dealers another is that since the abolition of fixed commissions a distinction has arisen between full service brokers who provide investors with investment information and discount brokers who charge lower commissions and provide only transaction services 1 the information produced by broker research is typically provided free of charge to investors in the expectation that it will stimulate trade rewarding the brokerage house with commissions 2 this paper compares the sale of investment information in return for a brokerage commission with direct sale for a fixed payment and indirect sale through the provision of investment management services in return for a

path dependence in risky choice affective and deliberative processes in brain and behavior decision makers show an increased risk appetite when they gamble with previously won money the house money effect and when they have a chance to make up for a prior loss the break even effect to explore the origins of these effects we use functional magnetic resonance imaging to record the brain activities of subjects while they make sequential risky choices the behavioral data from our experiment confirm the path dependence of choices despite the short trial duration and the many task repetitions required for neuroimaging the brain data yield evidence that the increased risk appetite after gains and losses is related to an increased activity of affective brain processes and a decreased activity of deliberative brain processes

good day sunshine stock returns and the weather psychological evidence and casual intuition predict that sunny weather is associated with upbeat mood this paper examines the relationship between morning sunshine in the city of a country s leading stock exchange and daily market index returns across 26 countries from 1982 to 1997 sunshine is strongly significantly correlated with stock returns after controlling for sunshine rain and snow are unrelated to returns substantial use of weather based strategies was optimal for a trader with very low transactions costs however because these strategies involve frequent trades fairly modest costs eliminate the gains these findings are difficult to reconcile with fully rational price setting

measuring investment performance in a rational expectations equilibrium model much research has been concerned with evaluating the performance of managed portfolios e g mutual funds and examining whether portfolio managers display in some sense superior performance superior performance would seemingly turn on the possession of superior information that is utilized in managing portfolios in general a fund s asset holdings or portfolio weights might not be observable to an outsider whether they are or not however they are likely to change over time this happens especially when better performance is a result of superior information since managers will change their portfolio composition on obtaining private information since such changes must be taken into account the problem of measuring performance of managed portfolios is inherently different from that of evaluating the performance of individual assets groups of assets or generally portfolios with constant and known composition

when cheaper is better fee determination in the market for equity mutual funds abstract in this paper we develop a model of the market for equity mutual funds that captures three key characteristics of this market first there is competition among funds second fund managers ability is not observed by investors before making their investment decisions third some investors do not make optimal use of all available information the main results of the paper are that 1 price competition is compatible with positive mark ups in equilibrium and 2 worse performing funds set fees that are greater or equal to those set by better performing funds these predictions are supported by available empirical evidence

poker player behavior after big wins and big losses we find that experienced poker players typically change their style of play after winning or losing a big pot most notably playing less cautiously after a big loss evidently hoping for lucky cards that will erase their loss this finding is consistent with kahneman and tversky s kahneman d a tversky 1979 prospect theory an analysis of decision under risk econometrica47 2 263 292 break even hypothesis and suggests that when investors incur a large loss it might be time to take a vacation or be monitored closely

management compensation and market timing under portfolio constraints abstract this paper shows that portfolio constraints have important implications for management compensation and performance evaluation in particular in the presence of portfolio constraints allowing for benchmarking can be beneficial benchmark design arises as an alternative effort inducement mechanism vis a vis relaxing portfolio constraints numerically we solve jointly for the manager s linear incentive fee and the optimal benchmark the size of the incentive fee and the risk adjustment in the benchmark composition are increasing in the investor s risk tolerance and the manager s ability to acquire and process private information

staying ahead and getting even risk attitudes of experienced poker players abstract frequent online poker players with extensive experience calculating probabilities and expected values might be expected to behave as expected utility maximizers in that small shocks to their wealth would not affect risk preferences rabin 2000 by contrast reference dependent loss aversion as in prospect theory koszegi and rabin 2006 kahneman and tversky 1979 predicts that risk aversion decreases as wealth moves away from the reference point in either direction in terms of continuing to play as well as a more aggressive playing style we find strong evidence for the break even effect the increased pursuit of risk as a player is losing within a session players behavior also appears consistent with existing evidence on reference dependent labor supply in their tendency to reduce effort and risk taking in response to being ahead our findings provide evidence for reference dependent behavior in a flexible high skilled setting under conditions of well understood monetary risk

collateral and competitive equilibria with moral hazard and private information the authors examine equilibrium credit contracts and allocations under different competitivity specifications and explain the economic roles of collateral under these specifications both moral hazard and adverse selection are considered the principal message is that how a competitive equilibrium is conceptualized significantly affects the characterization of equilibrium credit contracts specifically some well known results in the rationing literature are shown to rest delicately on the adopted equilibrium concept two somewhat surprising results emerge first high quality borrowers with unlimited collateral may be priced out of the market despite the bank having idle deposits second high quality borrowers may put up more collateral this paper explores the allocational consequences of alternative credit market competitivity specifications and explains the different economic roles of collateral under these specifications we model banks that lend to borrowers financing projects with payoffs depending on a priori unknown borrower attributes and ex post unobservable borrower actions borrowers are assumed to have unconstrained access to collateral our analysis is based on two concepts of competitive equilibrium under both banks compete in the sense that they earn zero expected profits however under the first concept of equilibrium ti as in jaffee and russell 11 all rents accrue to borrowers whereas under the second concept t2 all rents accrue to depositors as in stiglitz and weiss 17 our research makes two main points first we demonstrate that the manner in which a competitive equilibrium is conceptualized importantly influences the characterization of equilibrium credit allocations specifically one of the findings is that the rationing equilibria of stiglitz and weiss 17 and others should be viewed as rather delicate things in that they are very sensitive to the competitivity specification used for instance

the dynamics of portfolio management contracts we consider the multiperiod relationship between a client and a portfolio manager and the resulting problem of motivating a manager of unknown ability to acquire valuable information we explore the contractual forms and the optimal retention policy of the client and find that the optimal initial set of contracts features a smaller performance based fee component paid to the manager than in a first best contract and the contract choice elicits only partial information about the manager as a result ex post performance measurement is critical to future recontracting in general managers are retained only if the returns on their portfolio exceed the benchmark by an appropriate amount article published by oxford university press on behalf of the society for financial studies in its journal the review of financial studies

beating irrationality does delegating to it alleviate the sunk cost effect we investigate the impact of delegating decision making to information technology it on an important human decision bias the sunk cost effect to address our research question we use a unique data set containing actual market transaction data for approximately 7 000 pay per bid auctions in contrast with the laboratory experiments of previous related studies our research presents the unique advantage of investigating the effects of it enabled automated bidding agents on the occurrence of a decision bias in real market transactions we identify normatively irrational decision scenarios and analyze consumer behavior in these situations our findings show that participants with a higher behavioral investment are more likely to violate the assumption of normative economic rationality because of the sunk cost effect more importantly we observe that the delegation of auction participation i e actual bidding to it significantly reduces the occurrence of the sunk cost effect in subsequent decisions made by the same individual we can attribute this reduction to the comparably lower behavioral investments incurred by auction participants who delegate their bidding to it in particular by mitigating different contributors of behavioral investments delegating to it reduces the likelihood of the occurrence of the sunk cost effect by more than 50 this paper was accepted by sandra slaughter information systems

adverse risk incentives and the design of performance bases contracts this paper uses option pricing theory to value and analyze many performance based fee contracts that are currently in use a potential problem with some of these contracts is that they may induce portfolio managers to adversely alter the risk of the portfolios they manage the paper is prescriptive in that it presents conditions for contract parameters that provide proper risk incentives for classes of investment strategies for buy and hold and rebalancing strategies adverse risk incentives are avoided when the penalties for poor performance outweigh the rewards for good performance

house money effects on trust and reciprocity in a typical laboratory investment game experiment participants endowments are provided by the experimenter thus the worst case for the investor is that she loses all of her found money by contrast in naturally occurring environments investment decisions can often lead to a loss of one s own money this paper investigates whether trust found in one shot anonymous laboratory interaction is robust to own money environments our results show that consistent with previous investment game results most investors send a positive amount and most trustees return at least the transfer amount regardless of whether the investors purchase or are gifted their endowment however investments are on average lower when participants use their own money and the fraction of maximum investments the most risky investment decision is only half as large under own money as it is under gifted endowments our results explain why one should exercise caution in placing trust in any government s ability to spend other people s money prudently

welfare aspects of current u s corporate taxation the corporate income tax has provided a steadily declining fraction of federal revenues during the postwar era accounting for 23 0 percent during fiscal year 1966 and 14 2 13 9 and 10 2 percent in 1971 1976 and 1981 respectively however for several reasons aggregate tax collections are of limited use in measuring the distortionary impact of the corporate tax first one must allow for cyclical and potentially long run changes in the rate of profit to measure changes in average tax rates more fundamental problems lie in attempts to relate such an average tax rate to the desired measure the marginal tax rate assets of different age cohorts historically have faced different tax schedules because of a succession of nonretroactive tax law changes average tax rates on current income represent an amalgam of such tax rules furthermore even with a constant tax schedule the taxable income which serves as the base of the corporate tax diverges systematically from economic income because of the investment tax credit and the acceleration of depreciation allowances relative to actual economic depreciation an asset typically receives deductions and credits that are more than sufficient to shelter all income associated with it in the years immediately after purchase but faces a tax base exceeding economic income in more distant years after all depreciation allowances have been used up this implies that taxes will vary as a fraction of income depending on the age structure of assets fast growing firms will face low and potentially negative average tax rates on current income though facing the same tax schedule as stagnant firms with positive current tax payments this ignores the further complications that arise from the asymmetric treatment accorded gains and losses which i discuss below finally there may be serious distortions in the allocation of capital within the corporate sector that aggregate tax rates average or marginal cannot measure these difficulties have led to the general use and acceptance of the effective tax rate to measure the distortionary effects of the tax system this rate is based on a comparison of beforeand after tax internal rates of return on investment projects letting rg and rn be these two measures we define the effective tax rate to be

neoclassical theory versus prospect theory evidence from the marketplace several experimental studies have provided evidence that suggest indifference curves have a kink around the current endowment level these results which clearly contradict closely held economic doctrines have led some influential commentators to call for an entirely new economic paradigm to displace conventional neoclassical theory e g prospect theory which invokes psychological effects this paper pits neoclassical theory against prospect theory by investigating data drawn from more than 375 subjects actively participating in a well functioning marketplace the pattern of results suggests that prospect theory adequately organizes behavior among inexperienced consumers but consumers with intense market experience behave largely in accordance with neoclassical predictions moreover the data are consistent with the notion that consumers learn to overcome the endowment effect in situations beyond specific problems they have previously encountered this transference of behavior across domains has important implications in both a positive and normative sense

equilibrium prices in the presence of delegated portfolio management abstract this paper analyzes the asset pricing implications of commonly used portfolio management contracts linking the compensation of fund managers to the excess return of the managed portfolio over a benchmark portfolio the contract parameters the extent of delegation and equilibrium prices are all determined endogenously within the model we consider symmetric fulcrum performance fees distort the allocation of managed portfolios in a way that induces a significant and unambiguous positive effect on the prices of the assets included in the benchmark and a negative effect on the sharpe ratios asymmetric performance fees have more complex effects on equilibrium prices and sharpe ratios with the signs of these effects fluctuating stochastically over time in response to variations in the funds excess performance

performance incentive fees an agency theoretic approach this paper employs recent developments in agency theory to study the impact that com pensation contracts have on portfolio management investment decisions in a restricted mean variance world two types of incentive contracts for mutual fund managers are ana lyzed and compared the results show that the symmetric contract while not necessar ily eliminating agency costs dominates the bonus contract in aligning the manager s interests with those ofthe investor investment companies and by extension their managers control a large and increasing percentage ofthe aggregate wealth of their clients more investors are putting their money under the control of these advisers than ever before con sequently potential conflicts of interest arise between investment company own ers and their financial management advisers the securities and exchange com mission sec has been concerned with this issue for a number of years the agency has commissioned several studies to investigate the issue and has set forth certain rulings concerning the behavior of investment company advisers of par ticular importance has been the compensation arrangement between mutual fund management and the fund owners in fact the sec has issued specific guidelines regarding allowable fee schedules for managers these guidelines have ied to a policy debate concerning whether the sec has been too stringent or not stringent enough in regulating compensation for investment managers the present study takes a new approach to this problem in an attempt to resolve this debate the fiduciary relationship between mutual fund management and the inves tors they represent may be viewed as a principal agent relationship conse quently the methodology from the agency literature can be applied to study the impact of various compensation arrangements on the potential conflict of interest between these two groups

fund families as delegated monitors of money managers because a money manager learns more about her skill from her management experience than outsiders can learn from her realized returns she expects inefficiency in future contracts that condition exclusively on realized returns a fund family that learns what the manager learns can reduce this inefficiency cost if the family is large enough the family s incentive is to retain any given manager regardless of her skill but when the family has enough managers it adds value by boosting the credibility of its retentions through the firing of others as the number of managers grows the efficiency loss goes to zero

professional trader discipline and trade disposition recent evidence indicates irrational behavior among retail investors they hold onto losses and sell winners in a manner consistent with the disposition effect market professionals often use the term discipline to indicate trading strategies that minimize potential behavioral influences we investigate the nature of trading discipline and whether professional traders are able to avoid the costly irrational behaviors found in retail populations the full time traders in our sample hold onto losses significantly longer than gains but we find no evidence of costs associated with this behavior the successful floor futures traders in our sample exhibit trading behavior characterized as rational and disciplined moreover measures of relative trading discipline have predictive power for subsequent trading success

optimal portfolio choice under incomplete information models of asset pricing generally assume that the variables which characterize the state of the economy are observable however the distributional properties of asset prices that are relevant for portfolio decisions are in general not observable and therefore must be estimated the estimation of expected returns is a particularly difficult problem and estimation errors are likely to be substantial in this light it is reasonable to examine whether the assumption of observability of expected returns and other relevant state variables causes significant mis specification in equilibrium models of asset prices this paper has three main objectives first to derive optimal estimators for the unobservable expected instantaneous returns using observations of past realized returns second to establish that estimation and portfolio choice can be solved in two separate steps third to analyze the impact of estimation error on investment choices the estimators of expected returns are in general not consistent i e the estimation error does not tend to disappear asymptotically the effects of the estimation error therefore cannot be ignored even if realized returns are observed continuously over an infinite time period

the relative size of windfall income and the permanent income hypothesis a reconciliation is offered for the diverse test results on friedman s permanent income hypothesis a large data sample of those receiving windfall income in the bureau of labor statistics 1972 1973 consumer expenditure survey is divided according to the size of the windfall relative to estimated permanent income a pattern of a declining marginal propensity to consume windfall income as the relative size of the windfall increases is apparent these results support the permanent income hypothesis for relatively large windfalls

intangible investment and ramsey capital taxation the standard analysis of optimal fiscal policy aggregates different types of assets into a unique capital good and all types of capital taxes into a unique capital tax this paper considers a disaggregated framework an economy with corporate and dividend taxes where firms invest in both tangible and intangible assets which can be expensed or sweat in our setup firms can always respond to changes in the timing of taxation we find that the optimal long run policy features zero corporate taxes and positive dividend taxes with labor and dividend taxes being identical moreover the initial capital levy is relatively small

gambling in contests with heterogeneous loss constraints i study the impact of asymmetric loss constraints on risk taking behavior in the contest model of seel and strack 2013 i derive the unique nash equilibrium outcome the equilibrium payoffs and comparative statics about the bankruptcy risk

estimation risk and incentive contracts for portfolio managers the fiduciary relationship between portfolio managers and the investors they represent may be viewed as a principal agent relationship and therefore we have used the methodology from the agency literature in economics and finance to study the impact of existing compensation arrangements on the conflicts of interest between these two groups in this paper we employ the assumptions of the capital asset pricing model and of estimation risk concerning beta to develop a model in which portfolio managers can through effort choose the parameters of the beta distribution our model entails moral hazard because the investor cannot observe the manager s action given certain utility functions we show that the presence of estimation risk leads the manager to choose a lower beta portfolio than otherwise and that no first best optimal contract exists we also show that managerial divergent behavior is related to the divergence in risk preferences between the manager and the investor by making slightly more stringent assumptions about preferences we show that there exist some conditions under which the manager will provide more effort but also a riskier portfolio than the investor prefers finally we show that the investor will prefer a manager who is less risk averse than the investor

private versus public ownership investment ownership distribution and optimality examined in this paper is the choice between private and public incorporation of an asset for an entrepreneur asset owner who hires a manager with superior information about the asset s return distribution public sale of equity is shown to be the preferred alternative when a capital market issue costs are low or b the asset s idiosyncratic risk is high and the owner is either sufficiently risk averse or sufficiently optimistic about the asset s expected return thus those as sets deemed most valuable by their owners will tend to be publicly incorporated the paper also explores the impact of incorporation mode private versus public and information structure on the firm s investment policy and ownership distribution the determinants of corporate ownership structure have attracted much attention see for example demsetz and lehn 7 the recent spate of leveraged buyouts lbo s and other activities designed to consolidate ownership structure and often to take it out of the public domain have raised questions about the optimality of public ownership of corporations a related issue is the link between real output and the mode of incorporation in firms with a separation of ownership and control do privately incorporated firms have systematically different investment policies from publicly incorporated firms if so aggregate output must be a function of the cross sectional distribution of incorporation modes in the economy there is also considerable interest in the impact of insider information a topic that concerns us in this paper we have two principal objectives the first is to explore the conditions that determine an asset owner s choice of incorporation for the asset that is when would the owner prefer to keep asset ownership private as opposed to having a portion of that ownership publicly traded in particular what is the role of the owner s perception of the value of the asset in this determination are the assets being taken privately more or less valuable than those that are publicly traded insights on this score should help in understanding corporate ownership structure evolution our second objective is to examine the impact of information structure symmetric versus asymmetric information and the firm s incorporation

herding in delegated portfolio management when is comparative performance information desirable abstract we address the issue of investors asset allocation decisions when portfolio management is delegated to an agent contrary to predictions from traditional financial theory it is shown that investors may not induce their manager to allocate funds to the asset with the highest return instead they may herd in their asset allocation decision and induce trade in a particular asset because another manager is trading in it and despite the presence of a more profitable alternative doing so allows investors to write an efficiency improving relative performance contract on the other hand herding leads investors to design wage contracts strategically resulting in more aggressive and thus less profitable trade in equilibrium we show that herding occurs when the cost of information is high information precision is low and when managers are sufficiently risk averse moreover when investors can decide whether or not to disclose information about their manager s performance they will not do so

racetrack betting and informed behavior abstract horse racing data permit interesting tests of attitudes toward risk the present paper studies a new sample of racetrack results from atlantic city new jersey the questions examined are 1 are the market odds the best data for predicting the order of finish 2 do horses go off at odds that reflect their true probability of winning 3 is there any evidence that late bettors have better information than early bettors it is found that market odds predict the order of finish well but that favorites are good bets and long shots are poor ones the data suggest that there does exist an informed class of bettors and that bettors are on the whole neither risk neutral nor risk averse

does it all add up benchmarks and the compensation of active portfolio managers in this article the authors examine theoretically the use of benchmark portfolios in the compensation of privately informed portfolio managers they find that the use of a benchmark and particularly the types of benchmarks often observed in practice cannot be easily rationalized specifically commonly used benchmark adjusted compensation schemes are generally inconsistent with optimal risk sharing and do not lead to the choice of an optimal portfolio for the investor moreover benchmarks do not help in solving potential contracting problems such as inducing the manager to expend effort or trying to screen out uninformed managers copyright 1997 by university of chicago press

a model of the demand for investment banking advising and distribution services for new issues this paper presents a theory of the demand for investment banking advising and distribution services for the case in which the investment banker is better informed about the capital market than is the issuer and the issuer cannot observe the distribution effort expended by the banker the optimal contract under which the offer price decision is delegated to the better informed banker in order to deal with the adverse selection and moral hazard problems resulting from the informational asymmetry and the observability problem is characterized the model demonstrates a positive demand for investment banking advising and distribution services and provides an explanation of the underpricing of new issues an investment banker performs three functions which may be of value to an issuer of new securities underwriting advising and distribution this paper presents a theory of the demand for investment banking advising and distribution services based on an informational asymmetry between an issuer of new securities and an investment banker ultimately a theory of the organization of the financial intermediary industry is required that would predict which firms would use which types of financial intermediaries for which purposes and which firms would raise capital without engaging the services of a financial intermediary only a limited set of such predictions are developed here in the context of a model of a fixedprice offering under a negotiated contract in which the investment banker is

optimal contracts in a continuous time delegated portfolio management problem this article studies the contracting problem between an individual investor and a professional portfolio manager in a continuous time principal agent framework optimal contracts are obtained in closed form these contracts are of a symmetric form and suggest that a portfolio manager should receive a fixed fee a fraction of the total assets under management plus a bonus or a penalty depending upon the portfolio s excess return relative to a benchmark portfolio the appropriate benchmark portfolio is an active index that contains risky assets where the number of shares invested in each asset can vary over time rather than a passive index in which the number of shares invested in each asset remains constant over time fund managers compensation schemes in a delegated portfolio management setting have been of special interest to both academics and practitioners academic interest stems in part from the rapid growth of managed funds over the last two decades gompers and metrick 1998 report that by december 1996 mutual funds pension funds and other financial intermediaries held discretional control over more than half of the u s equity market it is thus of importance to study the impact of institutional trading on asset prices and to integrate into one model both asset pricing and delegated portfolio management compensation as advocated by brennan 1993 allen and santomero 1997 and allen 2001 it is also important to understand the relationship between a manager s trading strategies and his implicit incentives or career concerns see e g brown harlow and starks 1996 brown goetzmann and park 1997 chevalier and ellison 1999 and chen and pennacchi 2000 these concerns include internal promotion from a small to a large fund higher outside offers and the flow of money through the fund under management 1 the importance of fund manager compensation is also underscored by congressional passage in 1970 of the amendment to

the disposition effect in securities trading an experimental analysis the disposition effect is the tendency to sell assets that have gained value winners and keep assets that have lost value losers disposition effects can be explained by the two features of prospect theory the idea that people value gains and losses relative to a reference point the initial purchase price of shares and the tendency to seek risk when faced with possible losses and avoid risk when a certain gain is possible our experiments were designed to see if subjects would exhibit disposition effects subjects bought and sold shares in six risky assets asset prices fluctuated in each period contrary to bayesian optimization subjects did tend to sell winners and keep losers when the shares were automatically sold after each period the disposition effect was greatly reduced

competition in portfolio management theory and experiment we explore theoretically and experimentally the general equilibrium price and allocation implications of delegated portfolio management when the investor manager relationship is nonexclusive our theory predicts that competition forces managers to promise portfolios that mimic arrow debreu ad securities which investors then combine to fit their preferences a weak version of the capital asset pricing model capm obtains where state prices relative to state probabilities implicit in prices of traded securities will be inversely ranked to aggregate wealth across states our experiment broadly corroborates the price and choice predictions of the theory however price quality deteriorates when only a few managers attract most of the available wealth wealth concentration increases because funds flow toward managers who offer portfolios closer to replicating ad securities as in the theory but also because funds flow to managers who had better performance in the immediate past an observation unrelated to the theory this paper was accepted by jerome detemple finance

evaluation periods and asset prices in a market experiment we test whether the frequency of feedback information about the performance of an investment portfolio and the flexibility with which the investor can change it influence her risk attitude in markets in line with the prediction of myopic loss aversion benartzi and thaler 1995 we find that more information and more flexibility result in less risk taking market prices of risky assets are significantly higher if feedback frequency and decision flexibility are reduced this result supports the findings from individual decision making and shows that markets do not eliminate such behavior

portfolio performance and agency the evaluation and compensation of portfolio managers is an important problem for practitioners optimal compensation will induce managers to expend eort to generate information and to use it appropriately in an informed portfolio choice our general model points the way towards analysis of optimal performance evaluation and contracting in a rich model optimal contracting in the model includes an important role for portfolio restrictions that are more complex than the sharing rule the agent s compensation gives the agent approximately to a benchmark return plus an incentive fee equal to a portfolio measure that is approximately the excess of return above the benchmark this measure is often used by practitioners but is simpler than the jensen measure and other measures commonly recommended in the academic literature in addition to the excess return above the xed benchmark the manager is given some additional incentive to take a position that deviates from the benchmark to remove an incentive to tend towards being a closet indexer ecient contracting involves restrictions on what portfolio strategies can be pursued and prior communication of the information gathered

multi period information markets abstract this article examines the single shot decision problem of a monopolistic information seller selling a flow of information in a dynamic framework in a generalized version of wang s 1993 economy it shows that the profit maximizing strategy of the seller is to sell his information as is but only to a fraction of traders it argues that this strategy of selling information is different from that in a static model mainly due to the very different nature of constraints faced by the information seller in a dynamic framework

prior consequences and subsequent risk taking new field evidence from the taiwan futures exchange we use a data set from market participants in the taiwan stock exchange capitalization weighted stock index options markets to demonstrate a strong positive relationship between prior trading outcomes and subsequent risk taking in particular investors in this market take above average risks in afternoon trading after morning gains the phenomenon is prevalent in all three types of market makers accounts and across different types of market participants our findings are consistent with the argument that prior outcomes affect subsequent risk taking through a relationship that is sensitive to the model parameters i e expected return trading period and curvature of the value function because prospect theory can predict both increased and decreased levels of subsequent risk taking we provide possible explanations behind the phenomenon and discuss reasons for the variety of findings in the existing literature