Performance-sharing optimization by risk-constrained equity investors

Kris Boudt and Mulazim-Ali Khokhar

Finance Research Letters, 2021, vol. 38, issue C

Abstract: An investment project may be capital constrained when its risk exceeds the risk limit of prospective investors. We propose a new equity-contract in which the project’s performance-sharing across investors respects the individual investor’s risk limit while staying as close as possible to his/her percentage contribution in equity of the project. The proposed arrangement of performance-sharing thus ensures that the investors with constrained risk limits take less share of performance during high-risk episodes, while the less constrained investors are more exposed. The former pay a premium to the latter to compensate for the partial risk transfer. The proposed performance-sharing agreement is expected to be especially useful for risk-constrained equity investors who are restricted in their use of risk-free investments to reduce investment risk.

Keywords: Performance-sharing optimization; Investor risk limit; Risk-sharing; Risk-transfer; Musharakah (search for similar items in EconPapers)
Date: 2021
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Persistent link: https://EconPapers.repec.org/RePEc:eee:finlet:v:38:y:2021:i:c:s1544612320301793

DOI: 10.1016/j.frl.2020.101527

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