Asset Choice Regulation in Mutual Funds
55 Pages Posted: 22 Jul 2004
Date Written: March 15, 2004
Should the type of assets held by mutual funds be regulated? We investigate this issue in a costly state verification model, where the regulator determines the type of assets in which mutual funds can invest, fund managers select assets under this constraint, and investors can, at a cost, control the performance of the manager. The optimal level of risk for the portfolio reflects the following trade-off: On the one hand risky assets magnify the manager's incentives to lie, on the other hand they enhance the incentives of the investor to monitor performance. We show that regulation helps protect investors by restricting the discretion of the fund manager.
Keywords: mutual funds, portfolio choice, regulation
JEL Classification: G11, G23, G28, D82
Suggested Citation: Suggested Citation