On the Perils of Security Pricing by Financial Intermediaries: The Case of Open-End Mutual Funds

There are many instances where financial claims trade at prices set by intermediaries. Pricing by an intermediary introduces the potential for economic distortions from innumerable sources. As one example, we show that nonsynchronous-trading generates predictable, readily exploitable, changes in mutual fund-share prices (NAV). The exploitation of predictable changes in mutual fund NAVs involved a wealth transfer from buy-and-hold fund investors to active fund traders and is costly to all fund investors. A simple modification to the mutual fund pricing algorithm eliminates much of this predictability, but nonsynchronous trading is just one of the issues intermediaries face when setting prices.