Template-Type: ReDIF-Paper 1.0
Series: Tinbergen Institute Discussion Papers
Creation-Date: 2002-05-17
Number: 02-046/2
Author-Name: Arjen Siegmann
Author-Email: asiegmann@feweb.vu.nl
Author-Name: André Lucas
Author-Email: alucas@feweb.vu.nl
Author-Workplace-Name: Faculty of Economics and Business Administration, Vrije Universiteit Amsterdam
Title: Explaining Hedge Fund Investment Styles by Loss Aversion
Abstract: Recent research reveals that hedge fund returns exhibit a range of different,possibly non-linear pay-off patterns. It is difficult to qualify all these patternssimultaneously as being rational in a traditional framework for optimal financial decisionmaking. In this paper we present a simple model based on loss aversion that can accommodatefor all of these pay-off structures in one unifying framework. We provide evidence thatloss-aversion is a likely assumption for management as well as investor preferences.Following the current empirical literature, we solve a static asset allocation problem thatincludes a nonlinear instrument. We show analytically that four different pay-off functionsmay be rationally optimal. The key parameter in determining which of these four to choosein a specific setting, is the financial planner's surplus. The notion of surplus connectshedge fund manager's incentive schemes with the idea of mental accounting as proposed inrecent behavioral finance research.
Classification-JEL: G11,G23
Keywords: hedge funds; performance measurement; loss aversion; behavioral finance
File-Url: https://papers.tinbergen.nl/02046.pdf
File-Format: application/pdf
File-Size: 223199 bytes
Handle: RePEc:tin:wpaper:20020046