Cautious Risk-Takers: Investor Preferences and Demand for Active Management

63 Pages Posted: 21 Mar 2012 Last revised: 31 Oct 2023

See all articles by Valery Polkovnichenko

Valery Polkovnichenko

Board of Governors of the Federal Reserve System

Kelsey D. Wei

University of Texas at Dallas

Feng Zhao

University of Texas at Dallas - Jindal School of Management

Date Written: Novermber 2012

Abstract

Actively managed mutual funds have distinct return distributions from their passive benchmarks and our theoretical analysis using tail-sensitive risk preferences suggests that active value and growth funds may serve to reduce downside risk and capture upside potential, respectively. Furthermore, tail-sensitivity measures estimated from the empirical pricing kernel have significant explanatory power for active fund flows, even after controlling for business cycles and market-wide sentiment. Finally, active funds, unlike their passive counterparts, have exposures to option strategies hedging downside risk or capturing upside potential.

Keywords: tail-sensitive preferences, probability weighting function, active management, mutual funds

JEL Classification: G11, G23

Suggested Citation

Polkovnichenko, Valery and Wei, Kelsey D. and Zhao, Feng, Cautious Risk-Takers: Investor Preferences and Demand for Active Management (Novermber 2012). Available at SSRN: https://ssrn.com/abstract=2022416 or http://dx.doi.org/10.2139/ssrn.2022416

Valery Polkovnichenko (Contact Author)

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

Kelsey D. Wei

University of Texas at Dallas ( email )

P.O. Box 830688
Richardson, TX 75083-0688
United States
9728835978 (Phone)

Feng Zhao

University of Texas at Dallas - Jindal School of Management ( email )

800 W. Campbell Rd. SM 31
Richardson, TX 75080
United States
972-883-5815 (Phone)

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