Skewing the Odds: Strategic Risk Taking in Contests

83 Pages Posted: 12 Oct 2013 Last revised: 2 Oct 2016

See all articles by Dawei Fang

Dawei Fang

University of Gothenburg - Center For Finance; University of Gothenburg - Department of Economics

Thomas H. Noe

University of Oxford - Said Business School; University of Oxford - Balliol College; Bank of Finland; European Corporate Governance Institute

Date Written: February 5, 2015

Abstract

We study contests where, subject only to a capacity constraint on mean performance, contestants compete for identical prizes by choosing random performance levels. The capacity constraint combined with the rank-contingent rewards makes win-small/lose-big strategies optimal. Equilibrium strategies are generally skewed but never risk maximizing. When capacity is known and symmetric, we derive a closed-form solution for the game and analyze the effects of contest selectivity and size on equilibrium outcomes. We next consider contests where capacity is private information and show that, contrary to the risk-taking-and-ruin intuition, weak contestants do not always gamble on high-risk strategies. In fact, when the capacities of weak and strong contestants differ sufficiently, weak contestants choose low-variance performance distributions that never top strong contestants' performance, ensuring that the equilibrium is perfectly selection efficient. Finally, we consider the implications of our analysis for mutual fund tournaments, R&D competition, and stochastic contests.

Keywords: contests, risk taking, rank-based selection, skewness preference, R&D competition, stochastic contests, relaxed Colonel Blotto game

JEL Classification: C7, D00, G00, G11, G24

Suggested Citation

Fang, Dawei and Noe, Thomas H., Skewing the Odds: Strategic Risk Taking in Contests (February 5, 2015). Available at SSRN: https://ssrn.com/abstract=2339212 or http://dx.doi.org/10.2139/ssrn.2339212

Dawei Fang (Contact Author)

University of Gothenburg - Center For Finance ( email )

Box 640
Gothenburg, 403 50
Sweden

University of Gothenburg - Department of Economics ( email )

Sweden

Thomas H. Noe

University of Oxford - Said Business School ( email )

Park End Street
Oxford, OX1 3BJ
United Kingdom

University of Oxford - Balliol College ( email )

Broad St
Oxford, OX1 3BJ
United Kingdom

Bank of Finland ( email )

P.O. Box 160
FIN-00101 Helsinki
Finland

European Corporate Governance Institute ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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