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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.

Suggested Citation

  • Jeremy C. Stein, 2004. "Why Are Most Funds Open-End? Competition and the Limits of Arbitrage," NBER Working Papers 10259, National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberwo:10259
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    References listed on IDEAS

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    Blog mentions

    As found by EconAcademics.org, the blog aggregator for Economics research:
    1. Reforming mutual funds: a proposal to improve financial market resilience
      by Steve Cecchetti and Kim Schoenholtz in Money, Banking and Financial Markets on 2016-09-19 17:46:34

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    Cited by:

    1. Christopher J. Neely & Paul A. Weller, 2007. "Central bank intervention with limited arbitrage," International Journal of Finance & Economics, John Wiley & Sons, Ltd., vol. 12(2), pages 249-260.
    2. Bradley Jones, 2015. "Asset Bubbles; Re-thinking Policy for the Age of Asset Management," IMF Working Papers 15/27, International Monetary Fund.

    More about this item

    JEL classification:

    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G20 - Financial Economics - - Financial Institutions and Services - - - General

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