Indexing and Stock Price Efficiency

Financial Management, Vol. 44, Issue 4, 875-904, 2015

46 Pages Posted: 19 Mar 2013 Last revised: 18 Feb 2016

See all articles by Nan Qin

Nan Qin

College of Business, Northern Illinois University

Vijay Singal

Virginia Tech

Date Written: December 31, 2014

Abstract

Indexing has experienced substantial growth over the last two decades because it is an effective way of holding a diversified portfolio while minimizing trading costs and taxes. In this paper, we focus on one negative externality of indexing: the effect on efficiency of stock prices. Based on a sample of large and liquid U.S. stocks, we find that greater indexing leads to less efficient stock prices, as indicated by stronger post-earnings-announcement drift and greater deviations of stock prices from the random walk. We conjecture that reduced incentives for information acquisition and arbitrage induced by indexing and passive trading are probably the main causes for degradation in price efficiency.

Keywords: indexing, index funds, ETFs, passive institutional investors, stock price efficiency, passive trading

JEL Classification: G14, G23

Suggested Citation

Qin, Nan and Singal, Vijay, Indexing and Stock Price Efficiency (December 31, 2014). Financial Management, Vol. 44, Issue 4, 875-904, 2015. Available at SSRN: https://ssrn.com/abstract=2229263 or http://dx.doi.org/10.2139/ssrn.2229263

Nan Qin (Contact Author)

College of Business, Northern Illinois University

1425 W. Lincoln Hwy.
DEKALB, IL 60115
United States

Vijay Singal

Virginia Tech ( email )

Blacksburg, VA 24061
United States
5402317750 (Phone)

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