Obfuscation, Learning, and the Evolution of Investor Sophistication

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 sophistica- tion in mutual fund markets. Taking into account different learning mechanisms within the investor population, we characterize the op- timal timing of obfuscation for financial institutions who offer retail products. We show that educational initiatives that are directed to fa- cilitate learning by investors may induce providers to increase wasteful obfuscation, further disorienting investors and decreasing overall wel- fare. Obfuscation decreases with competition among firms, since the information rents from obfuscation dissipate as each institution attracts a smaller market share.