Tournament incentives and the risk-taking behavior of contestants: Theory and experiment

Contests form an integral part of modern life; sometimes explicitly, as in state-sponsored R&D races, but more often implicitly, as when fund managers compete for rankings.

In many contests, agents can try reaching top performance by taking risks, which can in turn affect financial stability and innovation speed, among other things.This project, which lasts for three years and consists of four parts, aims to use theory and experiments to deepen our understanding of the risk-taking behavior of contestants, as well as how to discourage (or encourage) risk taking when it is called for.

The first two parts will study risk-taking in fund-manager competitions.

We will provide new knowledge on whether and how downside penalties curb excessive managerial risk taking, as well as on how different reward/penalty structures affect volatility and skewness of fund returns.

In the third part, we will study how risk taking affects the efficiency of contests to select the most able contestant and will provide methods to improve selection efficiency of contests.

In the last part, we will study risk-taking in R&D races and provide policy implications on how to speed up innovation.Throughout, we will develop models which allow for asymmetric tail risks; most existing models are more restrictive.

As our recent publications show, allowing for asymmetric tail risks can bring many new insights on the relationship between competition and risk taking, an outcome we expect for this project.