information acquisition and mutual strongfundsstrong.pdf

Information acquisition and mutual funds∗ Diego Garc´ıa† Joel M. Vanden December 17, 2008 Abstract We study the formation of mutual funds by generalizing the standard competitive noisy rational expectations framework. In our model, informed agents set up mutual funds as a means of selling their private information to uninformed agents. We study the case of im- perfect competition among fund managers, where uninformed agents invest simultaneously in multiple mutual funds. The size of the assets under management in the mutual fund industry is determined by endogenizing the agents’ information acquisition decisions. Our model yields novel predictions on the informativeness of price, the optimal fees of mutual funds, and the equilibrium risk premium. In particular, we show that a sufficiently compet- itive mutual fund sector yields more informative prices and a lower equity risk premium. JEL classification: D43, D82, G14. Keywords : mutual funds, information acquisition, rational expectations equilibrium, markets for information. ∗We thank Shmuel Baruch, Jonathan Berk, Josh Coval, Peter DeMarzo, Espen Eckbo, Ken French, Thomas George, Alan Kraus, Steve Ross, Matthew Slaughter, Branko Uroˇsevi´c and Josef Zechner for comments on an early draft, as well as seminar participants at MIT, UBC, Penn State, Houston, UNC at Chapel-Hill, Queens’ University, the Econometric Society Winter meetings (Philadelphia, 2005), the Winter Finance Workshop (Rev- elstoke, 2004), the FIRS conference on banking, insurance and intermediation (Capri, 2004), the Arison School of Business (IDC Herzliya), the European Finance Association meetings (Maastricht, 2004), and the European Econometric Soci