Tournament effects in equity mutual funds: Impact of economic conditions and investment styles

Abstract Mutual funds engage in annual competitions to secure top positions in year‐end performance rankings. One effect implies that losing funds increase their risk more than winning funds, hoping to improve their rankings. Another effect involves a rational response by winning funds that anticipate the actions of losing funds and take more risk to maintain their position. We propose a novel testing approach that can better capture systematic risk shifting. We find evidence of a rational response when using traditional measures, but models that account for investment‐style variations weaken considerably the effects and detect more risk shifting by losing funds.