Index Investing and Asset Pricing under Information Asymmetry and Ambiguity Aversion
45 Pages Posted: 17 Jan 2017 Last revised: 29 Sep 2019
Date Written: September 27, 2019
In a setting with information asymmetry and a tradable value-weighted market index, ambiguity averse investors hold undiversified portfolios, and assets have non-zero alphas. But when a passive fund offers the risk-adjusted market portfolio (RAMP) whose weights depend on information precisions as well as market values, all investors hold the same portfolios as in the economy without model uncertainty and thus engage in index investing. So RAMP improves participation and risk sharing. Asset alphas are zero with RAMP as pricing portfolio. RAMP can be implemented by a fund of funds even if no single manager has sufficient knowledge to do so.
Keywords: index fund, index investing, CAPM, Information Asymmetry, ambiguity aversion
JEL Classification: G11, G12, D84
Suggested Citation: Suggested Citation