On Index Investing
48 Pages Posted: 20 Oct 2017 Last revised: 8 May 2020
Date Written: May 6, 2020
We empirically examine the effects of index investing. Consistent with equilibrium models such as Grossman and Stiglitz (1980), an increase in index investing leads to a reduction in information production, yet price informativeness is unchanged because investor behavior endogenously adjusts. Increased index investing leads to a decrease in Google search volume, EDGAR page views, and analyst reports, but does not limit trading by active investors. In fact, trading volume and short interest both rise while a variety of price informativeness measures are unchanged. Thus, while index investing changes investor composition and information production, it does not alter price informativeness.
Keywords: active management, arbitrageurs, index investing, limits to arbitrage, market efficiency, passive investing
JEL Classification: G12, G14
Suggested Citation: Suggested Citation