Incentive Fees with a Moving Benchmark and Portfolio Selection under Loss Aversion

Constantin Mellios and Anh Ngoc Lai ()
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Constantin Mellios: PRISM Sorbonne - Pôle de recherche interdisciplinaire en sciences du management - UP1 - Université Paris 1 Panthéon-Sorbonne
Anh Ngoc Lai: CREM - Centre de recherche en économie et management - UNICAEN - Université de Caen Normandie - NU - Normandie Université - UR - Université de Rennes - CNRS - Centre National de la Recherche Scientifique

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Abstract: This paper studies, in a unified and dynamic framework, the impact of fund managers compensation (symmetric and asymmetric fees including a penalty component) as well as their investment in the fund when managers exhibit a loss aversion utility function. Contrary to the vast majority of the existing literature, the benchmark portfolio, relative to which a fund's performance is measured, is risky. The optimal portfolio value comprises a call option and a term resembling the optimal value when the benchmark is riskless. The proportion invested in the risky security is a speculative position, while the fraction invested in the benchmark contains both a hedging addend and a speculative element. Our model and simulations show that (i) a risky benchmark substantially modifies the manager's allocation compared to a riskless benchmark; (ii) optimal positions are less risky when the manager is compensated by symmetric fees or faces a penalty; (iii) a relatively large manager's stake (30%) in the fund considerably reduces her risk-taking behaviour and results in an almost identical terminal portfolio value for the different fees schemes; (iv) optimal weights significantly react to different parameter values; (v) these results may have important implications on regulation.

Date: 2022
New Economics Papers: this item is included in nep-ban and nep-upt
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Published in Finance, 2022, 43, pp.79-110. ⟨10.3917/fina.432.0081⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-03708926

DOI: 10.3917/fina.432.0081

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