Working Paper: NBER ID: w10259
Authors: Jeremy C. Stein
Abstract: The majority of asset-management intermediaries (e.g., mutual funds, hedge funds) are structured on an open-end basis, even though it appears that the open-end form can be a serious impediment to arbitrage. I argue that the equilibrium degree of open-ending in an economy can be excessive from the point of view of investors. When funds compete for investors' dollars, they may engage in a counterproductive race towards the open-end form, even though this form leaves them ill-suited to undertaking certain types of arbitrage trades. One implication of the analysis is that, even absent short-sales constraints or other frictions, economically large mispricings can coexist with rational, competitive arbitrageurs who earn small excess returns.
Keywords: arbitrage; open-end funds; closed-end funds; market efficiency
JEL Codes: G12; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| open-end structure (L17) | competitive environment (L13) |
| competitive environment (L13) | quality of managerial talent (M54) |
| open-end structure (L17) | quality of managerial talent (M54) |
| quality of managerial talent (M54) | persistence of mispricings (G19) |
| open-end structure (L17) | persistence of mispricings (G19) |
| open-end structure (L17) | short-horizon strategies (L21) |
| short-horizon strategies (L21) | lower expected returns (G12) |