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Why Are Most Funds Open-End? Competition and the Limits of Arbitrage

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  • 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.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 10259.

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Date of creation: Feb 2004
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Publication status: published as Stein, Jeremy C. "Why Are Most Funds Open-end? Competition And The Limits Of Arbitrage," Quarterly Journal of Economics, 2005, v120(1,Feb), 247-272.
Handle: RePEc:nbr:nberwo:10259

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