In this thesis, I present a fresh analysis of the risk-taking behaviour of mutual fund managers in response to their relative performance. The mutual fund industry produces implicit incentives for fund managers to exhibit tournament-like behaviour where they compete with one another and alter their portfolio risk to maximise the inflows from investors. Despite the extensive amount of research on tournament behaviour, empirical evidence suggests contradictory conclusions. A more robust framework is required.
This thesis extends the literature in 3 ways. First, I find strong evidence of semi-annual tournament behaviour in the mutual fund industry. The results indicate that fund managers alter their portfolio risk regularly within the year, consistently coordinating with the investors' investment behaviour to maximise fund inflows. Second, I find non-linearity in risk-taking behaviour within the interim losers and winners groups. The induced incentives experienced by the fund managers relative to the past performance are more complex than documented in prior literature. Finally, I validate the importance of market conditions in the determinants of risk-taking behaviour. On the basis of this analysis, I argue that the traditional tournament hypotheses are insufficient to fully explain the tournament behaviour of fund managers. A new theoretical framework which adequately integrates and unfolds the incongruous evidence and hypotheses in the past literature is proposed. In brief, in a down market, unfavourable conditions act as a barrier to the interim winners thus preventing unnecessary risk-taking. As for the interim losers, having nothing to lose, gambling seems to yield the highest probability of a "comeback" in the tournament. Inversely, with an up market, favourable conditions permit the interim winners to increase their portfolio risk to a greater extent with much confidence, as they expect the corresponding interim losers to take additional risks.