High-Water Marks and Hedge Fund Management Contracts with Partial Information

Dandan Song (), Jinqiang Yang () and Zhaojun Yang

Computational Economics, 2013, vol. 42, issue 3, 327-350

Abstract: This paper extends the Goetzmann et al. (J Financ 58:1685–1717, 2003 ) model to the case of partial information, where the expected return of a hedge fund is not observable but known to be either high or low. The fund manager can dynamically update his belief about the true value of the expected return based on the realization of the net asset value of the hedge fund. Our main purpose is to study the impact of the uncertainty of the expected return on the pricing of the fund manager’s various fees and the investor’s claim. The results show that partial information has significant impact on the values of the fees and the claim. Specifically, a non-updating fund manager always underestimate the values, and more often than not, the amount underestimated is very significant. The closer the net asset value gets to the high-water mark or the larger the uncertainty of the expected return is, the bigger the amount underestimated will become. Copyright Springer Science+Business Media New York 2013

Keywords: High-water mark; Hedge fund; Performance fee; Partial information (search for similar items in EconPapers)
Date: 2013
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Citations: View citations in EconPapers (3)

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DOI: 10.1007/s10614-012-9338-7

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