Portfolio Selection, Periodic Evaluations and Risk Taking

Abstract

Portfolio risk taking when periodic performance matters Incentives of portfolio managers in real life are typically tied to their periodic performance—a criterion that has received very little attention to date. How does the repeated nature of the rewards influence the portfolio managers’ trading strategies? Tse and Zheng address this question via a dynamic model of investment in “Portfolio selection, periodic evaluations, and risk taking.” The return benchmark of the periodic evaluations plays a crucial role. A reasonable benchmark in conjunction with periodic payouts can mitigate excessive risk taking during market downturns. However, an overly aggressive benchmark could result in limited portfolio growth as well as ruin risk over the long run. The theoretical findings yield policy implications over incentives management and remuneration structure design to better align the short-term periodic interest of the portfolio managers and the long-term performance goal of the stakeholders.