The Perils of Security Pricing by Financial Intermediaries
Mutual fund prices are set using a mechanical algorithm. This algorithm often uses stale prices to calculate mutual fund prices because less actively traded and foreign stocks often have prices that are not up to date. As a result, surprisingly large trading profits are available to mutual fund traders. Unfortunately, these trading profits come at the expense of the other mutual fund investors. In order to protect mutual fund investors from opportunistic mutual fund traders, we demonstrate that an effective way to fix this pricing problem is to update stock prices that have not traded recently. This paper has been presented at the Investment Companies Institute and the U.S. Securities and Exchange Commission. Recently the SEC has taken action to try and address this problem.
"On the Perils of Security Pricing by Financial Intermediaries: The Wildcard Option in Transacting Mutual Fund Shares," by John M.R. Chalmers, Roger M. Edelen, and Gregory B. Kadlec, forthcoming in The Journal of Finance.
View the full paper (PDF 143K) at:
http://www.afajof.org/Pdf/forthcoming/wildcard.pdf