Why do fund managers increase risk?

This paper examines the relationship between the increase in fund risk and subsequent cash flows. We attempt to test the hypothesis that an increase in fund risk actually increases the net flows of equity funds, which is a basic assumption of risk shifting. We find that a change in fund risk has a positive and convex relationship with the fund's net flows. The effect of risk changes on net flows is a natural consequence of its effects on inflows and outflows. This paper's empirical results are robust to return frequency, fund age, and fund size. Our findings create incentives for managers to shift risk as documented in the mutual fund literature.