Front-Running by Mutual Fund Managers: It Ain't that Bad

CEPR Discussion Paper Series Number 1528

Posted: 9 Apr 1997

See all articles by Jean-Pierre Danthine

Jean-Pierre Danthine

University of Lausanne - Institute of Banking and Finance (IBF); Centre for Economic Policy Research (CEPR); Swiss Finance Institute

Serge Moresi

Charles River Associates (CRA)

Date Written: December 1996

Abstract

This paper evaluates the welfare implications of front-running by mutual fund managers. It extends the model of Kyle (1985) to a situation in which the insider with fundamentals-information competes against an insider with trade-information and in which noise trading is endogenized. Noise traders are small investors trading through mutual funds to hedge non-tradable or illiquid assets. The insider with trade-information is one of the fund managers. We find that front-running activity reduces their customer?s liquidity costs, but it also reduces their hedging benefits. As a result, the customers of the front-running manager may be worse off and place smaller orders. The opposite is true, for those investors who are not subject to front-running, however. In aggregate, front-running will either have no effect, or have a positive effect on welfare.

JEL Classification: G10

Suggested Citation

Danthine, Jean-Pierre and Moresi, Serge, Front-Running by Mutual Fund Managers: It Ain't that Bad (December 1996). CEPR Discussion Paper Series Number 1528, Available at SSRN: https://ssrn.com/abstract=8265

Jean-Pierre Danthine (Contact Author)

University of Lausanne - Institute of Banking and Finance (IBF) ( email )

Lausanne, 1015
Switzerland
+41 21 692 3485 (Phone)
+41 21 692 3335 (Fax)

HOME PAGE: http://www.hec.unil.ch/jdanthine/

Centre for Economic Policy Research (CEPR)

London
United Kingdom

Swiss Finance Institute ( email )

c/o University of Geneve
40, Bd du Pont-d'Arve
1211 Geneva, CH-6900
Switzerland

Serge Moresi

Charles River Associates (CRA) ( email )

1201 F Street, NW
Suite 700
Washington, DC 20004
United States
(202)662-3847 (Phone)

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