Why are Most Funds Open-End? Competition and the Limits of Arbitrage

44 Pages Posted: 31 Jan 2004 Last revised: 15 Jul 2010

See all articles by Jeremy C. Stein

Jeremy C. Stein

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

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Date Written: February 2004

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

Stein, Jeremy C., Why are Most Funds Open-End? Competition and the Limits of Arbitrage (February 2004). NBER Working Paper No. w10259, Available at SSRN: https://ssrn.com/abstract=495764

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