Rewarding Trading Skills Without Inducing Gambling

Igor Makarov and Guillaume Plantin ()
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Igor Makarov: MIT Sloan - Sloan School of Management - MIT - Massachusetts Institute of Technology
Guillaume Plantin: ECON - Département d'économie (Sciences Po) - Sciences Po - Sciences Po - CNRS - Centre National de la Recherche Scientifique, Tepper School of Business - CMU - Carnegie Mellon University [Pittsburgh]

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Abstract: This paper develops a model of active asset management in which fund managers may forgo alpha-generating strategies, preferring instead to make negative-alpha trades that enable them to temporarily manipulate investors' perceptions of their skills. We show that such trades are optimally generated by taking on hidden tail risk, and are more likely to occur when fund managers are impatient and when their trading skills are scalable, and generate a high profit per unit of risk. We propose long-term contracts that deter this behavior by dynamically adjusting the dates on which the manager is compensated in response to her cumulative performance.

Keywords: Trading skills; Active asset maagement; Financial strategies (search for similar items in EconPapers)
Date: 2015-06
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Citations: View citations in EconPapers (5)

Published in Journal of Finance, The (AFA), 2015, 70 (3), pp.925 - 962

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Persistent link: https://EconPapers.repec.org/RePEc:hal:spmain:hal-01178107

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