How Are Derivatives Used? Evidence from the Mutual Fund Industry

Jennifer Koski and Jeffrey Pontiff

Center for Financial Institutions Working Papers from Wharton School Center for Financial Institutions, University of Pennsylvania

Abstract: Approximately 20 percent of the 675 equity mutual funds analyzed in this paper invest in derivatives. We compare the return distributions of equity mutual funds that invest in derivatives to those that do not. We also analyze the use of derivatives to affect intertemporal changes in fund risk. Equity mutual funds that invest in derivatives have similar risk and similar net return performance in those that do not. Change in fund risk is negatively related to past performance, but derivatives allow funds to dampen these changes. We interpret these results as consistent with the hypothesis that managers are slow to respond to unexpected cash flows, and inconsistent with gaming of incentive compensation systems.

This paper was presented at the Financial Institutions Center's May 1996 conference on "

Date: 1996-05
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Journal Article: How Are Derivatives Used? Evidence from the Mutual Fund Industry (1999)
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