The Journal of Finance publishes leading research across all the major fields of finance. It is one of the most widely cited journals in academic finance, and in all of economics. Each of the six issues per year reaches over 8,000 academics, finance professionals, libraries, and government and financial institutions around the world. The journal is the official publication of The American Finance Association, the premier academic organization devoted to the study and promotion of knowledge about financial economics.
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High‐Water Marks: High Risk Appetites? Convex Compensation, Long Horizons, and Portfolio Choice
Published: 01/23/2009 | DOI: 10.1111/j.1540-6261.2008.01427.x
STAVROS PANAGEAS, MARK M. WESTERFIELD
We study the portfolio choice of hedge fund managers who are compensated by high‐water mark contracts. We find that even risk‐neutral managers do not place unbounded weights on risky assets, despite option‐like contracts. Instead, they place a constant fraction of funds in a mean‐variance efficient portfolio and the rest in the riskless asset, acting as would constant relative risk aversion (CRRA) investors. This result is a direct consequence of the in(de)finite horizon of the contract. We show that the risk‐seeking incentives of option‐like contracts rely on combining finite horizons and convex compensation schemes rather than on convexity alone.
Looking for Someone to Blame: Delegation, Cognitive Dissonance, and the Disposition Effect
Published: 08/06/2015 | DOI: 10.1111/jofi.12311
TOM Y. CHANG, DAVID H. SOLOMON, MARK M. WESTERFIELD
We analyze brokerage data and an experiment to test a cognitive dissonance based theory of trading: investors avoid realizing losses because they dislike admitting that past purchases were mistakes, but delegation reverses this effect by allowing the investor to blame the manager instead. Using individual trading data, we show that the disposition effect—the propensity to realize past gains more than past losses—applies only to nondelegated assets like individual stocks; delegated assets, like mutual funds, exhibit a robust reverse‐disposition effect. In an experiment, we show that increasing investors' cognitive dissonance results in both a larger disposition effect in stocks and a larger reverse‐disposition effect in funds. Additionally, increasing the salience of delegation increases the reverse‐disposition effect in funds. Cognitive dissonance provides a unified explanation for apparently contradictory investor behavior across asset classes and has implications for personal investment decisions, mutual fund management, and intermediation.
The Price Impact and Survival of Irrational Traders
Published: 01/20/2006 | DOI: 10.1111/j.1540-6261.2006.00834.x
LEONID KOGAN, STEPHEN A. ROSS, JIANG WANG, MARK M. WESTERFIELD
Milton Friedman argued that irrational traders will consistently lose money, will not survive, and, therefore, cannot influence long‐run asset prices. Since his work, survival and price impact have been assumed to be the same. In this paper, we demonstrate that survival and price impact are two independent concepts. The price impact of irrational traders does not rely on their long‐run survival, and they can have a significant impact on asset prices even when their wealth becomes negligible. We also show that irrational traders' portfolio policies can deviate from their limits long after the price process approaches its long‐run limit.