Index Funds, Asset Prices, and the Welfare of Investors

40 Pages Posted: 3 Jan 2023 Last revised: 10 Sep 2023

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: September 10, 2023

Abstract

We study the effect of index funds on asset prices and the choices and welfare of investors. In our model, 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 wide variety of settings, we show that the net effect is that availability of the Fund decreases investor welfare.

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., Index Funds, Asset Prices, and the Welfare of Investors (September 10, 2023). 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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