Obfuscation, Learning, and the Evolution of Investor Sophistication

TLDR

Investor sophistication has lagged behind the growing complexity of retail financial markets. The study develops a dynamic model to examine how obfuscation interacts with investor sophistication in mutual fund markets. The model incorporates various investor learning mechanisms and determines the optimal timing of obfuscation for institutions offering retail products. Educational initiatives that facilitate investor learning can prompt providers to increase wasteful obfuscation, further disorienting investors and reducing welfare, while competition among firms reduces obfuscation as information rents dissipate.

Abstract

Investor sophistication has lagged behind the growing complexity of retail financial markets. To explore this, we develop a dynamic model to study the interaction between obfuscation and investor sophistication in mutual fund markets. Taking into account different learning mechanisms within the investor population, we characterize the optimal timing of obfuscation for financial institutions who offer retail products. We show that educational initiatives that are directed to facilitate learning by investors may induce providers to increase wasteful obfuscation, further disorienting investors and decreasing overall welfare. Obfuscation decreases with competition among firms, since the information rents from obfuscation dissipate as each institution attracts a smaller market share.