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Tracking Biased Weights: Asset Pricing Implications of Value-Weighted Indexing

CEPR Discussion Paper No. DP15563

61 Pages Posted: 23 Dec 2020

See all articles by Hao Jiang

Hao Jiang

Michigan State University

Dimitri Vayanos

London School of Economics; Center for Economic Policy Research (CEPR); National Bureau of Economic Research (NBER)

Lu Zheng

University of California, Irvine - Paul Merage School of Business

Multiple version iconThere are 3 versions of this paper

Date Written: December 2020

Abstract

We show theoretically and empirically that flows into index funds raise the prices of large stocks in the index disproportionately more than the prices of small stocks. Conversely, flows predict a high future return of the small-minus-large index portfolio. This finding runs counter to the CAPM, and arises when noise traders distort prices, biasing index weights. When funds tracking value-weighted indices experience inflows, they buy mainly stocks in high noise-trader demand, exacerbating the distortion. During our sample period 2000-2019, a small-minus-large portfolio of S&P500 stocks earns ten percent per year, while no size effect exists for non-index stocks.

JEL Classification: G10, G11, G12, G23

Suggested Citation

Jiang, Hao and Vayanos, Dimitri and Zheng, Lu, Tracking Biased Weights: Asset Pricing Implications of Value-Weighted Indexing (December 2020). CEPR Discussion Paper No. DP15563, Available at SSRN: https://ssrn.com/abstract=3753963

Hao Jiang (Contact Author)

Michigan State University ( email )

315 Eppley Center
Department of Finance
East Lansing, MI 48824
United States

HOME PAGE: http://sites.google.com/site/haojiangfinance/

Dimitri Vayanos

London School of Economics ( email )

A350
Houghton Street
London WC2A 2AE
United Kingdom
+44 (0)20 7955 6382 (Phone)
+44 (0)20 7955 7420 (Fax)

Center for Economic Policy Research (CEPR)

London
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Lu Zheng

University of California, Irvine - Paul Merage School of Business ( email )

Paul Merage School of Business
Irvine, CA California 92697-3125
United States
9498248365 (Phone)

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