Information Asymmetry and the Mutual Fund Market

Abstract

The literature is still divided about the information asymmetry problems of actively managed mutual funds. This disagreement raises an issue about the conditions behind the existence of this market. Some authors support the existence of market clearing mechanisms, while others estimate that passive funds are a substitute for active funds and the higher fees charged for the latter are not justified. We contribute to this discussion by formalizing these two approaches in price-setting strategies in two subgames. To solve it, we resort to an “external body” with a defined role to coordinate investors and mutual funds. We find that, owing to the actions of the external body and the presence of sophisticated investors and a low-quality mutual fund, there are incentives to deliver high-quality service and the active mutual fund market is preserved.