Mutual Fund Tournaments: The Sorting Bias and New Evidence

Abstract

Researchers have found conflicting results concerning the risk-taking response of underperforming first half mutual fund managers to economic incentives. We show analytically, numerically and empirically that the sorting process typically used in prior studies drives risk-taking findings. When we correct for this issue using a new methodology, we find that first half underperforming managers increase the risk of their portfolios in the second half of the year. We also find that this second half “tournament behavior” is unrelated to equity market returns in the first half of the year.