NEW YORK - The recent market timing and late trading allegations brought forth by New York Attorney General Eliot Spitzer have sparked a renewed interest in how mutual fund firms determine fair value. The crux of the matter is that many fund shares are bought and sold at incorrect prices due to time zone differences. Quantitative research in the past few years has made the industry aware that the use of stale prices affords market timers the opportunity to realize significant gains at the expense of shareholders.

For example, a U. S. fund that invests in Japanese stocks can manipulate the system with a simple strategy. Since the Nikkei will have been closed for hours when this fund calculates the value of its net assets at 4 p.m. in New York, its share price will not reflect any news from the last several hours. Market timers can use this stale pricing to make an easy profit without having to get help from a mutual fund to trade after the market close in New York. Traders can buy foreign funds immediately before the close on a day when the U.S. stock market has enjoyed a nice rally, and sell whenever the market has sharply declined. This strategy exploits the tendency of foreign markets to piggyback the U.S. market.

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