DFG Project: Designing Financial Products to Exploit Limited Attention of Retail Investors

In this four-year project, Markus Dertwinkel-Kalt from the University of Münster and André Romahn from HHU Düsseldorf are investigating the effects of limited attention on the investment behavior of retail investors. For this purpose, they use experimental as well as field or market data. They are particularly interested in salience effects that firms can exploit with little effort, i.e., those related to the labeling of financial products, to their relative positioning, and to the marketing of particular investment strategies. There is ample evidence that financial firms exploit such salience effects. For example, the number of funds and different categories of funds has increased dramatically over the past 20 years. In the last 5 years, there have been more investable indexes in the U.S. than listed companies. On average, there are only 5 funds that use a single index as a reference, and three quarters of all indices are used by only a single fund. Funds based on such niche indices charge their investors higher management fees on average than competing offerings based on widely used indices. Looking at the market for indexes, it is notable that in 2018, the three largest providers together accounted for 80 percent of total index-linked financial assets under management. Standard models of economics can hardly explain such patterns. Alternative models that explicitly incorporate investors' limited cognitive capacity are more promising in this regard. In order to make evidence-based economic policy decisions, it is necessary to understand the operation of salience effects and to be able to measure them quantitatively. Using an experimental approach, researchers aim to understand (1) how benchmark indices can be chosen to make products appear more attractive and thus increase issuers' profits, and (2) which investment strategies can be prominently marketed to increase investment volume. Experiments and a structural model will be used to quantify and test whether (3) salient labels and benchmark indices can be used to increase demand for financial products with disadvantageous cost structures. A purely structural approach will be used to investigate (4) how policies that limit the availability of niche indices and increase the consideration of relevant information by retail investors affect investor welfare and the profits of index and fund providers. This project is a project within the DFG Research Group on "Consumer:Internal Preferences, Consumer:Internal Errors, and Corporate Response."