On Index Investing
61 Pages Posted: 20 Oct 2017 Last revised: 1 Mar 2022
Date Written: January 1, 2022
We empirically examine the effects of index investing using predictions derived from a Grossman-Stiglitz framework. An exogenous increase in index investing leads to lower information production as measured by Google searches, EDGAR views, and analyst reports, yet price informativeness remains unchanged. These findings are consistent with an equilibrium in which investors choose to gather private information whenever it is profitable. As index investing increases, there are fewer privately-informed active investors (so overall information production drops), but the remaining mix of investors adjusts until the returns to active investing are unchanged. As a result, passive investing does not undermine price efficiency.
Keywords: active management, arbitrageurs, index investing, limits to arbitrage, market efficiency, passive investing
JEL Classification: G12, G14
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