Time-zone arbitrage in United States mutual funds: Damaging to financial integration between the United States, Asia and Europe?

Abstract

Historically, United States mutual funds have often calculated their asset values for international mutual funds using stale prices, because some fund components finish trading before the market closes. This resulted in daily fund returns becoming predictable. This allows an arbitrage opportunity for investors who move their money at the end of the United States trading day to profit from the next-day change in Asian and European equities. This acts as a tax on other investors in mutual funds that hold non-United States assets. This paper quantitatively traces the history of this phenomenon, known as time-zone arbitrage (TZA), in various mutual funds, particularly the Vanguard Fund Family, before and after the phenomenon became well known. The opportunity for TZA has diminished but not disappeared. This shrinkage together with the advent of Exchange-Traded Funds – which are not subject to time-zone arbitrage – makes investment in Asia and Europe more profitable for American mutual fund investors. This should increase United States investment in Asia and Europe and enhance the integration of these markets.