Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds
James J. Choi
Yale School of Management; National Bureau of Economic Research (NBER)
Harvard University - Department of Economics; National Bureau of Economic Research (NBER)
Brigitte C. Madrian
Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)
NBER Working Paper No. w12261
Experimental subjects allocate $10,000 across four S&P 500 index funds. Subject rewards depend on the chosen portfolio's subsequent return. Because the investments are not actually intermediated by the fund companies, portfolio returns are unbundled from non-portfolio services. The optimal portfolio therefore invests 100% in the lowest-cost fund. Nonetheless, subjects overwhelmingly fail to minimize fees. When we make fees transparent and salient, portfolios shift towards cheaper funds, but fees are still not minimized. Instead, subjects place high weight on normatively irrelevant historical returns. Subjects who choose high-cost index funds are relatively much less confident about their asset allocation choices.
Number of Pages in PDF File: 47
Date posted: July 17, 2006
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