Explaining Hedge Fund Investment Styles by Loss Aversion

Arbeitspapier

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.

Object Details

• Language: Englisch

References and Relationships

• Bibliographic citation: Series: Tinbergen Institute Discussion Paper ; No. 02-046/2

Classification and Topics

• Classification: Wirtschaft ; Portfolio Choice; Investment Decisions ; Pension Funds; Non-bank Financial Institutions; Financial Instruments; Institutional Investors
• Subject: hedge funds ; performance measurement ; loss aversion ; behavioral finance ; Investmentfonds ; Hedging ; Kapitaleinkommen ; Anlageverhalten ; Risikoaversion ; Finanzanalyse ; Theorie ; Hedgefonds

Contributors, Places and Time

• Event: Geistige Schöpfung
• (who): Siegmann, Arjen ; Lucas, André
• Event: Veröffentlichung
• (who): Tinbergen Institute
• (where): Amsterdam and Rotterdam
• (when): 2002

Further information

• Handle: http://hdl.handle.net/10419/85973
• Last update: 10.03.2025, 11:44 AM CET