75 Pages Posted: 2 Nov 2020 Last revised: 10 Jun 2021
Date Written: June 10, 2021
Benchmarking incentivizes fund managers to invest a fraction of their funds’ assets in their benchmark indices, and such demand is inelastic. We construct a measure of inelastic demand a stock attracts, benchmarking intensity (BMI), computed as its cumulative weight in all benchmarks, weighted by assets following each benchmark. Exploiting the Russell 1000/2000 cutoff, we show that changes in stocks’ BMIs instrument for changes in ownership of benchmarked investors. The resulting demand elasticities are low. We document that both active and passive fund managers buy additions to their benchmarks and sell deletions. Finally, an increase in BMI lowers future stock returns.
Keywords: Benchmark, preferred habitat, index effect, demand elasticity, mutual funds, Russell cutoff
JEL Classification: G11, G12
Suggested Citation: Suggested Citation