Article

Rewarding Trading Skills without Inducing Gambling

Igor Makarov, and Guillaume Plantin

Abstract

This paper develops a model of active asset management in which fund managers may forego alpha-generating strategies, preferring instead to make negative-alpha trades that enable them temporarily to manipulate investors' perceptions of their skills. We show that such trades are optimally generated by taking on hidden-tail risk, and that they 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.

Reference

Igor Makarov, and Guillaume Plantin, Rewarding Trading Skills without Inducing Gambling, The Journal of Finance, vol. 70, n. 3, June 2015, pp. 952–962.

See also

Published in

The Journal of Finance, vol. 70, n. 3, June 2015, pp. 952–962