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How Widespread Was Late Trading in Mutual Funds?

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  • Eric Zitzewitz

Abstract

This paper uses daily fund flow data to examine the extent of late trading in the U.S. mutual fund industry. Trading decisions that are required by law to have been made before 4 PM Eastern Time are correlated with market movements from 4 to 9 PM that evening. The cross- sectional variation in this correlation is consistent with late trading being its primary cause and inconsistent with alternative explanations. For example, apparent late trading ceases in September 2003 after the announcement of the investigation into mutual fund trading practices, it is three times greater in fund families that have been cited by regulators for allowing late trading, and it is greater in funds and asset classes that are also receiving heavy stale price arbitrage flows. In my sample, which includes 75 percent of non-specialized equity mutual funds and 48 percent of assets, late trading led to average annual shareholder dilution from 1998 to 2003 of 3.8 and 0.9 basis points in international and U.S. equity funds, respectively. If these dilution rates prevailed industry wide, they would imply shareholder losses of about $400 million per year. Furthermore, there is statistically significant evidence of late trading in the funds of 39 of 66 fund families.
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Suggested Citation

  • Eric Zitzewitz, 2006. "How Widespread Was Late Trading in Mutual Funds?," American Economic Review, American Economic Association, vol. 96(2), pages 284-289, May.
    • Handle: RePEc:aea:aecrev:v:96:y:2006:i:2:p:284-289
    Note: DOI: 10.1257/000282806777211892
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    References listed on IDEAS

    as
    1. Goetzmann, William N. & Ivković, Zoran & Rouwenhorst, K. Geert, 2001. "Day Trading International Mutual Funds: Evidence and Policy Solutions," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 36(3), pages 287-309, September.
    2. Eric Zitzewitz, 2003. "Who Cares About Shareholders? Arbitrage-Proofing Mutual Funds," The Journal of Law, Economics, and Organization, Oxford University Press, vol. 19(2), pages 245-280, October.
    3. Chevalier, Judith & Ellison, Glenn, 1997. "Risk Taking by Mutual Funds as a Response to Incentives," Journal of Political Economy, University of Chicago Press, vol. 105(6), pages 1167-1200, December.
    4. Greene, Jason T. & Hodges, Charles W., 2002. "The dilution impact of daily fund flows on open-end mutual funds," Journal of Financial Economics, Elsevier, vol. 65(1), pages 131-158, July.
    5. Rahul Bhargava & Ann Bose & David A. Dubofsky, 1998. "Exploiting International Stock Market Correlations with Open-end International Mutual Funds," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 25(5&6), pages 765-773.
    6. Paul G. Mahoney, 2004. "Manager-Investor Conflicts in Mutual Funds," Journal of Economic Perspectives, American Economic Association, vol. 18(2), pages 161-182, Spring.
    7. Rahul Bhargava & Ann Bose & David A. Dubofsky, 1998. "Exploiting International Stock Market Correlations with Open‐end International Mutual Funds," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 25(5‐6), pages 765-773, June.
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    More about this item

    JEL classification:

    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • K42 - Law and Economics - - Legal Procedure, the Legal System, and Illegal Behavior - - - Illegal Behavior and the Enforcement of Law

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