Exploited by Complexity

Abstract

Existing research attributes investor return heterogeneity to individual characteristics such as
sophistication. We bring a new perspective from the supply side by showing that return heterogeneity can be magnified as assets offered by the market become more complex. Using
detailed account-level data, we examine the trading of B funds—complex, structured products
in the Chinese market. During a three-year market cycle, the return gap between the naive and
sophisticated is an order-of-magnitude greater when trading B funds than when trading simple,
non-structured funds. In an event study, we confirm that this disparity is driven by differences
in investors’ understanding of product complexity.

Keywords: Complexity, Household Finance