Are Hedge Fund Traders risk neutral?

I suppose this obviously depends on mandate, return requirements and trader psyche (what else?) but would you consider (some) hedge fund traders risk neutral, i.e., the next dollar they earn is always worth the same, call that one dollar, to them?

I guess, but I'm no expert on this topic yet by a long shot, they could be expected to earn, say, $30mm for the fund a given year and then be quite close to being risk neutral at first but then become increasingly risk averse once they passed their yearly mark - or not since they would be bonus focused, get rich quick and then retire kind of folks?

Comments (5)

Nov 12, 2013

I really don't know.

With some exceptions, most hedge fund traders just do what the researchers tell them to do, and generally do yeomans' work at it.

I think the researcher or the PM gets most of the upside at a hedge fund. I think the trader does a good job of helping the PM execute on his/her strategies.

I think that typically $30mm isn't in the cards for traders. I don't think $30mm is in the cards for most people, even in finance.

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Nov 12, 2013
IlliniProgrammer:

I really don't know.

With some exceptions, most hedge fund traders just do what the researchers tell them to do, and generally do yeomans' work at it.

I think the researcher or the PM gets most of the upside at a hedge fund. I think the trader does a good job of helping the PM execute on his/her strategies.

I think that typically $30mm isn't in the cards for traders. I don't think $30mm is in the cards for most people, even in finance.

Firstly, this above is a little misguided...

Secondly, in answer to the original question... In theory, yes, every dollar you make should be the same. However, in practice, there are all sorts of effects, including the one that OP is alluding to. It's impossible to generalize, as there's a variety of people doing a whole variety of thing in the mkt.

Nov 12, 2013

Thanks guys.

IlliniProgrammer:

I think that typically $30mm isn't in the cards for traders. I don't think $30mm is in the cards for most people, even in finance.

That was supposed to be the trading revenue for the firm. There should be quite a bit to deduct to arrive at pay.

Martinghoul:

In theory, yes, every dollar you make should be the same. However, in practice, there are all sorts of effects, including the one that OP is alluding to.

Are you just referring to human errs by the trader? Or also to setup of the fund, so that risk aversion is to some extent dictated by management? If the first, how does a trader's boss/manager incentivize traders to stay more risk neutral (anything else than bonus)?

Nov 12, 2013

First of all, I naturally assumed that the OP isn't referring to execution traders, as it's an extremely uninteresting question. Execution traders have no real reason to either be "non-neutral" nor to earn $30 mil for their fund (at least not to my knowledge).

So, presumably, the question applies to someone who, for the avoidance of confusing terminology, is a "risk taker" (a PM, for instance). In this case, effects such as the one that the OP alludes to (i.e. people who have made money tend to get increasingly risk averse towards the end of their accounting year) are a fact of life. In fact, these things are simply manifestations of common behavioral biases, which, believe it or not, HF risk takers aren't immune to. The effect that the OP mentioned in particular sounds like one of the basic illustrations of "prospect theory" in action. It's basic human nature, innit? And yes, some funds' incentive schemes are structured in such a way as to exacerbate these behavioral effects (reason being that individually irrational behavior may produce a better outcome for the fund as a whole). In light of this, it's not obvious to me what a boss/manager should do.

Nov 12, 2013

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