Obfuscation, Learning, and the Evolution of Investor Sophistication

Abstract

We develop a dynamic model to study the interaction between obfuscation and investor sophistication in retail financial markets. Taking into account different learning mechanisms within the investor population, we characterize the optimal timing of obfuscation for a profitmaximizing monopolist. We show that educational initiatives that are directed to facilitate learning by investors may induce producers to increase wasteful obfuscation, further disorienting investors and decreasing overall welfare. Obfuscation decreases with competition among firms, but increases with higher investor participation in the market. * We would like to thank

The flow-performance relationship around the world

“…Second, investor sophistication is expected to influence the top and bottom of the flow-performance relationship while participation costs are expected to be more influential for the middle and top 6 In more developed fund industries we expect a greater number of funds. It might be argued that this could make the informational participation costs of investing in mutual funds actually greater in more developed countries (Carlin and Manso, 2011). We investigate this empirically and find little evidence that the number of funds behaves like a participation cost.…”

“…It might be argued that this could make the informational participation costs of investing in mutual funds actually greater in more developed countries. Carlin and Manso (2011) develop a model demonstrating that the number of funds offerings may reduce the ability of investors to process information and make good fund selection decisions even if they are sophisticated. In order to investigate this further we include the number of funds in each country as a mutual fund industry development variable by interacting it with past fund performance.…”

A Unified Pricing of Variable Annuity Guarantees under the Optimal Stochastic Control Framework

“…Given that numerical solutions used for pricing of VA riders are complex, it is important that these solutions are properly tested and validated. Moreover, new products are appearing in the VA market regularly with increasing complexity that raises an important question, as discussed in [47] and mentioned in [23], whether new complex products are designed to suite the policyholder needs better or introduced for the purpose of obfuscation.…”

“…eliminates all the random terms in (47), making the portfolio locally riskless. This means that the portfolio earns at the risk-free interest rate r(t), i.e., dΠ t = rΠ t dt, leading to the PDE…”

Do 401k plan advisors take their own advice?

“…In a different theoretical model Inderst and Ottaviani (2011) view kickbacks as incentives to learn about appropriate investments for sophisticated clients and as tools of exploitation of unsophisticated clients. Carlin and Manso (2011) examine dynamic model of investor learning and financial product obfuscation. Carlin and Gervais (2009) explore the legal rules that maximize welfare in retail financial markets.…”