On Index Investing
53 Pages Posted: 20 Oct 2017 Last revised: 28 Aug 2020
Date Written: August 23, 2020
We empirically examine the effects of index investing using predictions derived from a Grossman-Stiglitz framework. An increase in index investing leads to lower information production as measured by Google searches, EDGAR views, and analyst reports, yet price informativeness remains unchanged. The findings are consistent with an equilibrium in which investors choose to be informed active traders whenever it is profitable. As index investing increases there are fewer informed active investors (so aggregate information production drops), but the remaining mix of informed and uninformed active investors adjusts until the returns to active investing are unchanged -- thus price informativeness is unchanged.
Keywords: active management, arbitrageurs, index investing, limits to arbitrage, market efficiency, passive investing
JEL Classification: G12, G14
Suggested Citation: Suggested Citation