2005

PROJECTS FUNDED IN 2005

The Rise of Teams in Fund Management

Massimo Massa, INSEAD

Jonathan Reuter,
University of Oregon
Eric W. Zitzewitz, Stanford University

Increasingly, mutual funds are turning from named portfolio managers to unnamed management teams. We propose to study the impact of this decision on managerial incentives and investor perceptions. On the one hand, we expect that associating a fund’s performance with a particular manager will generate higher inflows through more positive media mentions and higher returns. On the other hand, we expect that the use of unnamed management teams will limit the rents a high-performing manager can extract from the family by threatening to depart, and will increase the demand spillovers from one fund’s performance to the other funds in its family.

The Research Committee expects that this research will help our membership better understand the costs and incentives associated with alternative management contracts. Since many of our members participate in these contracts, we expect that the results should better inform decisions about how to structure their businesses.

Market Volatility, Investor Flows, and the Structure of Hedge Fund Markets

Link to PDF File: Market Volatility, Investor Flows, and the Structure of Hedge Fund Markets
Bill Ding, SUNY, Albany
Mila Getmansky, University of Massachusetts

Bing Liang,
University of Massachusetts
Russell R. Wermers, University of Maryland

Market observers and regulators often cite hedge funds as contributing substantially to the volatility of financial markets. In this project, we will study the characteristics of funds, and the structure of fund categories, that impact investor flows to these funds and fund categories. Further, we will test whether the structure of certain hedge funds, or hedge fund categories are more conducive to flows contributing to excessive market volatility, especially during extreme market events. Our study, by examining the impact of flows on the markets in which hedge funds invest, will provide an important, new perspective for investors in these funds.

The Research Committee expects that this research will help our membership better understand the factors that determine how sponsors allocate and withdraw the one trillion dollars that they now entrust to hedge funds. Since many of our members operate hedge funds, complete with them, or fund them, we expect that the results will allow them to better understand the environment within which they operate.

Informed and Strategic Order Flow in Bond and Stock Markets

Link to PDF File: Informed and Strategic Order Flow in Bond and Stock Markets
Paolo Pasquariello, University of Michigan
Clara Vega, University of Rochester

We study the role of private and public information in the U.S. Treasury bond market. We develop a model of speculative trading in the presence of two realistic market frictions-information heterogeneity and imperfect competition among informed traders-and a public signal. We test its implications by analyzing the response of two-year, five-year, and ten-year U.S. bond yields to order flow and real-time U.S. macroeconomic news. We find strong evidence of informational effects: unanticipated order flow has a significant and permanent impact on daily bond yield changes during both announcement and non-announcement days. Our analysis further shows that, consistent with our model, the contemporaneous correlation between order flow and yield change is higher when the dispersion of beliefs among market participants is high and public announcements are noisy.

The Research Committee expects that this research will help our membership better understand how what factors determine prices in the U.S. Treasury bond markets. The results will interest our member who trade Treasury bonds or how use signals from the Treasury bond markets when making other trading decisions.

Who Monitors the Mutual Fund Manager, New or Old Shareholders?

Woodrow T. Johnson, University of Oregon

When shareholders consider investing in a new fund, they presumably have access to several alternatives and ultimately choose a top-performing fund. Do shareholders trade in response to returns thereafter? This paper explores this question by decomposing the within-fund return-flow relationship. The first stage of the analysis compares buys with sells to see whether shareholders sell poor returns with the same vigilance they buy good returns. The second stage tests whether the return-buy relationships for account-opening buys and post-opening buys are the same. The final stage examines why shareholders do not sell in response to poor returns.

The Research Committee expects that this research will help our membership better understand the factors that make mutual fund flows sticky. The results have implications for our members who need to predict and accommodate fund flows, or who must allocate managerial talent to maximize funds under management. The results may also inform our members who use fund flows to make investment decisions.

Operational Risk

Link to PDF File:Operational Risk
Robert Jarrow, Cornell University

The purpose of this proposal is to provide an economic and mathematical characterization of operational risk, useful for quantification and estimation. This characterization will be based on insights from the corporate finance and credit risk literatures. From the corporate finance literature, the notion of agency costs will be crucial in characterizing operational risk. From the credit risk literature, the mathematical characterization of jumps in asset values will be utilized, in an arbitrage-free setting. Estimation of the model’s parameters will be discussed, but an empirical investigation is left for subsequent research.

The Research Committee expects that this research will produce tools that will allow our membership to better quantify and thus manage operational risk. All management firms and their sponsors face operational risk in additional to the many other risks with which we are so familiar. The proposed research will provide a framework within which these risks and their implications for the investment management process can be better quantified.


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