Resumen de Risk choice under high-water marks

Itamar Drechsler

• I solve in closed form for the optimal dynamic risk choice of a fund manager who is compensated with a high-water mark contract. The optimal risk choice depends on the ratio of the fund's assets under management to its high-water mark. If the manager's outside option value is low, investors' termination policy is strict, or management fees are high, then negative returns induce the manager into �derisking.� Otherwise, he engages in �gambling.� Having the option to walk away increases risk taking, though in many cases exercise is never optimal. In particular, leaving to restart at a proportionally smaller fund is always suboptimal.