Trading and Valuing Toxic Assets (Job Market Paper) |
Abstract: Fair value accounting forces institutions to revalue their inventory whenever a new transaction price is observed. An institution facing a balance sheet constraint can have incentives to suspend trading in opaque over-the-counter markets to obstruct further price discovery. This way the asset's book valuation can be kept artificially high, thereby relaxing the institution's balance sheet constraint. But, the institution looses direct control of its asset holdings, leading to possible excessive risk exposure. An institution optimally balances this tradeoff when choosing the point beyond which it suspends trading. Outside investors, who do not know at what price the asset would trade, reduce their valuation the longer the asset has not traded. Their expected discount from book value is convex in time since last trade and robust to parameter misspecifications. |
Fund flows and risk taking (Working Paper) |
Abstract: Hedge funds face performance related withdrawals to their assets under management.
As hedge fund managers’ compensation is closely linked to the assets under management,
they optimally take outflows into account in their investment decisions. I solve a continuous
time investment model where fund flows are connected to the relative distance of the current
assets under management to their high-water marks – also known as the current drawdown
– to show that: (i) managers become more conservative the closer they are to the high-water
mark; (ii) the possibility of stronger future outflows makes the manager more conservative
close to the high-water mark; (iii) this conservatism is reversed as current outflows become
larger - the stronger current outflows, the more risk the manager will take on even though
the risk-return tradeoff stays constant; (iv) waiving fees can be optimal for the manager
when far below the benchmark.
© 2008 Konstantin Milbradt |
Konstantin Milbradt