Diversification Bias and the Law of One Price: An Experiment on Index Mutual Funds
Journal of Behavioral Finance, Forthcoming
22 Pages Posted: 15 Jan 2015 Last revised: 4 Jan 2016
Date Written: January 14, 2015
Individual investors select high-fee index mutual funds despite the fact that the future payouts are nearly identical. We offer an explanation for this violation of the Law of One Price based on investor desire to diversify. While diversification in some settings may be beneficial, in the case of assets with identical payouts, fee minimization is the only rational strategy. Our evidence confirms that investors diversify by selecting multiple higher fee funds rather than minimizing fees when investing in index mutual funds.
Keywords: Mutual funds, S&P index funds, behavioral finance, diversification bias
JEL Classification: C91, D03, D14, G11, G23
Suggested Citation: Suggested Citation