Mutual Fund Competition and Stock Market Liquidity

55 Pages Posted: 8 Mar 2005

Date Written: December 2004

Abstract

We study how competition in the mutual fund industry affects stock market liquidity. We argue that mutual fund families operate as multi-product firms, jointly choosing fees, performance and number of funds and sharing common research facilities. The family-based organization generates economies of scale in information that induce a trade off between performance and number of funds. The presence of more and relatively less-informed funds impacts the market, increasing stock liquidity. This intuition allows us to use 'observable' equilibrium conditions in the mutual fund market that are related to fund informativeness (i.e., fees, size and performance of the funds and number of funds per family), to explain stock market liquidity. We test our theory using the universe of the US actively managed mutual funds in the past 20 years. We identify fund characteristics and relate them to stock liquidity. We show that the fund characteristics affect stocks in the way suggested by our theory: higher fees or better performance reduce stock liquidity, while a higher number of funds per family or bigger fund size increase stock liquidity. Proper identification allows us to pin down the direct impact of funds on stock liquidity, controlling for potential issues of reverse causality.

Keywords: Mutual funds, stock liquidity, financial intermediation

JEL Classification: G11, G12, G14

Suggested Citation

Massa, Massimo, Mutual Fund Competition and Stock Market Liquidity (December 2004). CEPR Discussion Paper No. 4787. Available at SSRN: https://ssrn.com/abstract=667962

Massimo Massa (Contact Author)

INSEAD - Finance ( email )

Boulevard de Constance
F-77305 Fontainebleau Cedex
France
+33 1 6072 4481 (Phone)
+33 1 6072 4045 (Fax)

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