Mutual Funds in Equilibrium

Historically, the literature on money management has not consistently applied the rational expectations equilibrium concept. We explain why and summarize recent developments in the money management literature that do apply this concept correctly. We demonstrate that in many respects the rational expectations equilibrium better approximates the observed equilibrium in the money management space than it does in the stock market. Moreover, many of the puzzles that have plagued the earlier literature result from failing to apply the equilibrium concept correctly. Recent work reveals that there is little support for the common conclusion that, as a group, investors in the money management space are naive and that mutual fund managers are charlatans. Even today, equilibrium thinking is not nearly as prevalent in mutual fund research as it is in the rest of asset pricing. This state of play provides a multitude of opportunities for future research in the area.