Review of Quantitative Finance and Accounting, 16: 205–222, 2001
2001 Kluwer Academic Publishers. Manufactured in The Netherlands.
A Fundamental Approach to Estimating Economies
of Scale and Scope of Financial Products: The Case
of Mutual Funds
JAMES S. ANG
Department of Finance, College of Business, Florida State University, Tallahassee, Florida 32306
JAMES WUH LIN
Department of Finance, College of Business, Montana State University, Bozeman, Montana 59717
Abstract. We propose a ‘Fundamental’ approach to estimate the economies of scale and scope for ﬁnancial
institutions offering multi-product lines. We ﬁrst estimate pure economies of scale from its fundamental deﬁnition,
which is the marginal cost reduction that is to be achieved by single product ﬁrms of increasing size that offer
the same product. Similarly, we estimate the economies of scope from its fundamental deﬁnition, as the marginal
cost reduction achieved by the addition of a new product line. Operationally, we compare the cost of operating a
say, 3 product-line ﬁnancial institution with the cost of operating a portfolios of companies that are synthetically
created from a control sample of ﬁnancial institutions offering fewer, such as 2 and 1 similar product lines. When
this approach is applied to mutual funds data, we ﬁnd economies of scale for some fund type. The evidence
on marginal cost economies due to increasing scope is rather weak. The results have practical implications for
potential organizers and current management of investment companies.
Key words: economies of scale and scope, mutual funds, diversiﬁcation
JEL Classiﬁcation: G20, L11, G23
A ﬁnancial institution may choose to offer from one specialized ﬁnancial product to several
diversiﬁed products (the issue of scope), and at different size of operation (the issue of scale).
The questions of whether scale (or scope) economies could be realized, and if not, what are
the costs due to sub optimal scale or scope are of relevance to those who are interested in
various private and public policy issues, such as, corporate restructuring including mergers
and spin-offs, regulations and deregulation, and the optimal organizational form. Thus, there
has been a continuing interest in the empirical estimations of scope (scale) economies and
efﬁciencies among ﬁnancial institutions. Not all ﬁnancial institutions operate with the same
degree of efﬁciency, some are better run than others due to higher quality management, better
utilization of its resources, lower agency problems, etc. Ultimately, measuring efﬁciency is
an empirical issue. However, there are several estimation problems that have to be solved,
from the speciﬁcation of the functional forms to the assumed behaviors of ﬁrms at or near
the efﬁcient cost frontier.
In this paper, we concentrate on the equally important but much
neglected problem of the role of data can play in obtaining better estimates.