Impact of managerial commitment on risk taking with dynamic fund flows

We present a model with dynamic investment flows, where fund managers have the ability to generate excess returns and study how forcing them to commit part or all of their personal wealth to the fund they manage affects fund risk taking. We contrast the behavior of a manager that may invest her personal wealth in a private account to a manager that is either forced to commit her wealth to the fund she manages, or a manager who is not allowed to hold risky assets held by the fund privately. We show that a fund managed by a manager with higher ability does not necessarily achieve higher expected returns but achieves lower idiosyncratic volatility. We also find that for a manager with constant ability, restrictions placed on her personal account do not influence her choices in the fund, while for a manager whose ability varies stochastically they result in higher expected returns and idiosyncratic volatilities and lower Sharpe ratios. Our results are robust to the case of incomplete information