Iso-risk: an analysis of risk-taking in fixed income markets |
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Authors: | Ben Van Vliet Apostolos Xanthopoulos |
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Institution: | 1. Stuart School of Business, Illinois Institute of Technology, Chicago, IL, USA;2. Mercer Investment Consulting LLC, Chicago, IL, USA |
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Abstract: | We test the hypothesis that portfolio managers trade-off variance and kurtosis in asset returns. We find empirical evidence that supports the iso-risk hypothesis using fixed income mutual fund data. Managers appear to systematically ‘swing for the fences’ when the probability of outperformance is low. This resolves previous enigmas of preference reversals and adheres to both Prospect Theory and tournament effects. The methodology developed enables reconciliation of active return metrics and managers’ total return behaviour. As the data set includes the great recession, we provide an economic interpretation of the results in light of the trade-off hypothesis. |
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Keywords: | Polynomial utility tournament effects investor behavior prospect theory iso-risk |
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