Do Index Funds Benefit Investors?

53 Pages Posted: 3 Jan 2023 Last revised: 14 May 2024

See all articles by Martin C. Schmalz

Martin C. Schmalz

CEPR; University of Oxford - Finance; CESifo; European Corporate Governance Institute (ECGI)

William R. Zame

University of California, Los Angeles (UCLA) - Department of Economics

Date Written: May 13, 2024

Abstract

The short answer is “Maybe not.” To demonstrate this possibility, we construct and study
two models in which investors choose among bonds, individual stocks, and an index Fund
that holds the market portfolio. Asset prices are determined endogenously. The availability
of the Fund induces investors to shift out of individual stocks and bonds and into the Fund.
The former shift reduces investor risk and increases investor welfare; the latter shift increases
asset prices and decreases investor welfare. In a variety of settings, we show that the net
effect is that availability of the Fund decreases welfare for some – even all – investors.

Keywords: portfolio choice, asset pricing, ownership, indexing, inequality, household finance

JEL Classification: D14, D53, G11, G12, G23

Suggested Citation

Schmalz, Martin C. and Schmalz, Martin C. and Zame, William R., Do Index Funds Benefit Investors? (May 13, 2024). Available at SSRN: https://ssrn.com/abstract=4246321 or http://dx.doi.org/10.2139/ssrn.4246321

Martin C. Schmalz (Contact Author)

University of Oxford - Finance ( email )

United States

CEPR ( email )

London
United Kingdom

CESifo ( email )

Poschinger Str. 5
Munich, DE-81679
Germany

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

William R. Zame

University of California, Los Angeles (UCLA) - Department of Economics ( email )

Box 951477
Los Angeles, CA 90095-1477
United States
310-206-9463 (Phone)

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