Effective Fair Pricing of International Mutual Funds

Abstract

We propose a new methodology to provide fair prices of international mutual funds by adjusting prices at the individual securities level using a comprehensive and economically relevant information set. Stepwise regressions are used to endogenously determine the stock-specific optimal set of instruments in estimating the fair price of each stock in a fund. We compare the performance of our approach with existing ones using 16 U.S.-based Japanese funds. Our method predicts significantly more accurately fund prices at next-day Japan open, which are the best proxies for the unobserved prices at U.S. close. The existing methods are shown to be highly vulnerable to speculative attacks while our method is the most successful in preventing such strategic exploitation in that no competing method can profit significantly from our stated price. Our method can profit from the existing methods significantly by between 12 to 40 percent annually. Simulation results show that our method is superior to existing ones regardless of the style of the funds, such as different turnover ratios, stock sizes, number of stocks in a fund, and book-to-market ratios.

Keywords: Stale pricing, Fair pricing, International mutual funds, Stepwise regression

JEL Classification: G10, G12, G15