Mutual Fund Arbitrage and Transaction Costs

Abstract:     
The 2003 mutual funds scandal that exploded upon the public revealed something that had long been known to insiders: Mutual fund advisers often approve and allow frequent trading, frequent trading arbitrage, and late trading arbitrage to selected traders. To increase adviser profits, the latter two arrangements often require traders to investment "sticky assets" to "grow" fund assets.

These costly mutual fund adviser practices increase transaction costs along several dimensions and lower current fund and shareholder assets, along with opportunity costs of dilution in fund share values and returns for long-term shareholders. Independent directors have either not been informed or have acquiesced in the decisions. In any case, independent directors have not performed their primary fiduciary duty as "shareholder watchdogs."

Number of Pages in PDF File: 24

Keywords: mutual funds, frequent trading, time zone arbitage, transaction costs, independent director watchdog failure, regulation

JEL Classification: G2, G23, G28

working papers series