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In our paper, we analyze the interplay of contestant heterogeneity and idiosyncratic risk in rank-order tournaments: While in symmetric tournaments an increase in idiosyncratic risk reduces incentives, in asymmetric tournaments this is not necessarily the case: Rather, we show that increasing the level of idiosyncratic risk in asymmetric tournaments will at first increase and—only after a critical risk level has been reached—reduce incentives. We find this critical risk level to be higher, the larger the degree of contestant heterogeneity. Concerning practical implications, it is more important to reduce idiosyncratic risk in the tournament when contestants are similar and less beneficial when contestants are heterogeneous. In light of the fact that equilibrium effort levels in tournaments with a low level of contestant heterogeneity are by far higher than those in tournaments with high levels of contestant heterogeneity, the advice would be to simultaneously reduce contestant heterogeneity (e.g., by league-building or handicapping) and idiosyncratic risk.

The Ambivalent Role of Idiosyncratic Risk in Asymmetric Tournaments