Financial Technology and the Inequality Gap
47 Pages Posted: 4 Nov 2019 Last revised: 11 May 2020
Date Written: April 1, 2019
Information-based models of capital income inequality that link return heterogeneity to different levels of investor sophistication overlook the possibility that poorer investor can avoid paying a large fixed cost for research, simply by buying shares in a fund. In this paper, I study capital income inequality in a framework where investors are heterogeneous in their initial wealth and have a choice between not investing and investing through a fund. I find that wealthier investors benefit from searching for informed funds since their search cost is low relative to their wealth. Hence, funds with wealthier investors are expected to outperform. Thus, the possibility to pool into funds does not help poorer investors, because they end up investing in worse funds than wealthier investors. Moreover, I find that when the cost of data processing falls, for the investor or the fund manager, more funds trade on information. This makes market participation less valuable for the less-well-informed. Since the marginal stock market participant is an investor in an uninformed fund, not an informed fund investor, this marginal participant is worse off and exits the market. This amplifies capital income inequality. Moreover, this also rationalizes why in the last decades, in spite of a dramatic reduction in the cost of individual investor trading and of fund management fees, the stock market participation rate has been declining as well.
Keywords: Quant Analysis, Inequality, Information Acquisition, Funds, Innovation.
JEL Classification: E21, G11, G14, L1, L15
Suggested Citation: Suggested Citation