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Are fund managers incentivised to ignore stock market jumps?

Chondrogiannis, I; Vivian, A; Freeman, M; (2020) Are fund managers incentivised to ignore stock market jumps? UCL School of Slavonic and East European Studies (SSEES): London, UK. Green open access

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Abstract

In this paper, we show that the way in which fund managers are compensated can, under plausible conditions, lead them to act in a way that does not maximise the wellbeing of their clients. Due to performance bonuses in fund managers' rewards, there is a highly non-linear relationship between the wealth of the client and the fees that the manager receives. We demonstrate that jumps in equity returns can lead to a conflict of interest between the investor and the manager in such a setting. Specifically, the managers' option-type payment structure can incentivise them to not account for the downside risk induced by jumps, especially if the fund manager is only in post for a few years; thus managers may pursue a more aggressive asset allocation strategy than their clients desire. Our key policy recommendation is that regulators should consider imposing a negative fund fee in times of very poor absolute fund performance to mitigate against suboptimal fund management asset allocation decisions.

Type: Working / discussion paper
Title: Are fund managers incentivised to ignore stock market jumps?
Open access status: An open access version is available from UCL Discovery
DOI: 10.14324/000.wp.10115623
Publisher version: https://doi.org/10.14324/000.wp.10115623
Language: English
Keywords: jump-diffusion, MCMC, tail risk, portfolio optimisation, risk management
UCL classification: UCL
UCL > Provost and Vice Provost Offices
UCL > Provost and Vice Provost Offices > UCL SLASH
UCL > Provost and Vice Provost Offices > UCL SLASH > SSEES
URI: https://discovery.ucl.ac.uk/id/eprint/10115623
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