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Incentive Contracts and Hedge Fund Management

Published online by Cambridge University Press:  06 April 2009

James E. Hodder  and
Jens Carsten Jackwerth
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Abstract

We investigate incentive effects of a typical hedge fund contract for a manager with power utility. With a one-year horizon, the manager displays risk taking that varies dramatically with fund value. We extend the model to multiple yearly evaluation periods and find that the manager's risk taking is rapidly moderated if the fund performs reasonably well. The most realistic approach to modeling fund closure uses an endogenous shutdown barrier where the manager optimally chooses to shut down. The manager increases risk taking as fund value approaches that barrier, and this boundary behavior persists strongly with multiyear horizons.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 4 , December 2007 , pp. 811 - 826
Copyright
Copyright © School of Business Administration, University of Washington 2007

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