risk behavior of the hedge manager
Several studies have tackled the issues about the taking of risk behavior of the hedge manager who has the asymmetric packages of compensation (incentives cost) and the connection of results on how the difficulties that may come along with the satisfactory response. Most incentives contracts look alike to a call option that gives the manager a chance to receive incentive fees and when assets value goes beyond the amount higher than a watermark. With the TASS database’s help, the hedge fund manager will always tend to either decrease or increase the response of risk to performance, which is relative to the contemporary and not about their performance. This can be argued in a positive direction in the direction of two comparisons between the volatility and the termination that will eventually provide the disincentive for any fund manager to gamble more excessively if the option is out of money. Carpenter (2000) explores a hedge fund manager’s behavior with an option contract of assets under management. Carpenter argues that such a manager increases the fund risk when the hedge fund’s return falls below the hurdle rate hence decreasing the risk. It also suggests that locking in the manager’s behavior, especially for option contracts.
Nevertheless, Carpenter’s analysis is based on a more extended period. It does not consider the possibility of the fund being liquidated due to the poor performance unless the hedge fund value is falling to zero. Moreover, the liquidation boundary is specified by other academicians like Ingersoll, Ross, and Goetzmann (2003) and Panageas & Westereld (2009). The academicians argued in their models that a hedge fund manager has the incentive to hike the risk exposed to him when the value of the option hikes with the increase in volatility, but upon the fund value approaching the liquidation boundary, the fund manager decreases the risk exposed to him.