The Prudent Investor Rule and Market Risk: An Empirical Analysis

Max M Schanzenbach*, Robert H. Sitkoff

*Corresponding author for this work

    Research output: Contribution to journalArticlepeer-review

    5 Scopus citations

    Abstract

    The prudent investor rule, enacted in every state over the last 30 years, is the centerpiece of trust investment law. Repudiating the prior law's emphasis on avoiding risk, the rule reorients trust investment toward risk management in accordance with modern portfolio theory. The rule directs a trustee to implement an overall investment strategy having risk and return objectives reasonably suited to the trust. Using data from reports of bank trust holdings and fiduciary income tax returns, we examine asset allocation and management of market risk before and after the reform. First, we find that the reform increased stockholdings, but not among banks with average trust account sizes below the 25th percentile. This result is consistent with sensitivity in asset allocation to trust risk tolerance. Second, we present evidence consistent with increased portfolio rebalancing after the reform. We conclude that the move toward additional stockholdings was correlated with trust risk tolerance, and that the increased market risk exposure from additional stockholdings was more actively managed.

    Original languageEnglish (US)
    Pages (from-to)129-168
    Number of pages40
    JournalJournal of Empirical Legal Studies
    Volume14
    Issue number1
    DOIs
    StatePublished - Mar 1 2017

    ASJC Scopus subject areas

    • Education
    • Law

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