Exploited by Complexity
72 Pages Posted: 28 Apr 2020 Last revised: 11 Sep 2020
Date Written: March 14, 2020
Due to their complex features, structured financial products can hurt the average investor. Are certain investors particularly vulnerable? Using account-level transaction data of retail structured funds, we show that the rich (sophisticated) benefit from complexity at the expense of the poor (naive). The poor-to-rich wealth transfer that results from trading structured funds is substantially greater than from trading simple, non-structured funds. In an event study, we further confirm that part of this wealth transfer can be directly attributed to investors’ differing responses to complexity. In particular, when a market crash triggers funds into a restructuring process and their prices are expected to shrink by half on a given day, the poor and naive subset of investors fail to respond effectively.
Keywords: Complexity, Household Finance
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