We hypothesise that the market Sharpe ratio depends on price discovery. We adapt Treynor and Black’s model, making Sharpe ratio endogenous on the proportion of investment that is actively managed. If investors recognise this endogeneity and improve their utility by investing such that price discovery ensures an optimal market Sharpe ratio, they will allocate to active strategies – even if these strategies underperform the market – thereby explaining the Grossman-Stiglitz paradox. If investors consider the market Sharpe ratio exogenous, they will not allocate to active, minimising market Sharpe ratio. We show that a self-financing levy maximises investor utility in this case.