The impact of prior performance on the risk-taking of mutual fund managers

We analyze the impact of prior performance on the risk-taking behavior of mutual fund managers. We contribute to the existing literature by using different measures of risks, a larger data set, and an econometric approach capturing non-linear effects and assigning exact probabilities to the mutual fund managers’ adjustment of behavior. We find that prior performance in the first half of the year has, in general, a positive impact on the choice of the risk level in the second half of the year. Successful fund managers increase the volatility, the beta, and assign a higher proportion of their portfolio to value stocks, small firms, and momentum stocks in comparison to unsuccessful fund managers. Unsuccessful fund manager increase, on average, only the tracking error. We thank an anonymous referee, Bernd Brommundt, Alexander Ising, Stephan Kessler, Axel Kind, Angelika Noll, Jennifer Noll, Ralf Seiz, Stephan Süss, Rico von Wyss, and Andreas Zingg for valuable comments. We acknowledge helpful comments of the participants from the Joint Research Workshop of the University of St. Gallen and the University of Ulm in 2005.