Please use this identifier to cite or link to this item: http://hdl.handle.net/10419/85973
Authors: 
Siegmann, Arjen
Lucas, André
Year of Publication: 
2002
Series/Report no.: 
Tinbergen Institute Discussion Paper 02-046/2
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.
Subjects: 
hedge funds
performance measurement
loss aversion
behavioral finance
JEL: 
G11
G23
Document Type: 
Working Paper

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