Oligopolistic Competition, Fund Proliferation and Asset Prices

We develop and estimate a dynamic oligopoly model of the passive mutual fund industry in which multiproduct asset management firms act as fund initiators and decide how many funds to launch in a given investment sector. Both mutual funds and management companies compete a la Cournot and take into account the demand for asset management services from a representative household investor. In the first part of the paper, we provide sufficient conditions for the existence and uniqueness of a steady-state equilibrium in which each management firm operates a constant number of funds and the equilibrium index price is constant. In the second part of the paper, we develop a nested fixed-point algorithm to estimate fund initiation costs separately for the five biggest management companies in the US passive equity industry by matching fund proliferation patterns observed in the data. We find that the top five companies are substantially more efficient and enjoy large scale economies relatively to the rest of the market. In a series of counterfactual exercises, we show that removing the largest management companies from the market would reduce investors' welfare by as much as 25%. Lastly, we characterize analytically the steady-state multiplier of household wealth on the equity index price in terms of the technology primitives of the industry. Our estimates imply that a 1% increase in household wealth increases the valuation of the equity index by 5.5%, consistent with other estimates in the literature