Designing Index Provision

Abstract

Despite the importance of indices, little is known about the index provision market. To understand the market's competitive landscape, we develop a model that incorporates three key players: retail investors, passive funds, and index providers. Index providers, established to mediate the conflict of interest between the other two, often prioritize the interests of their fund clients. Retail investors can influence the industrial-organizational structure of the index provision market by deciding how many indices are admitted. Contrary to conventional wisdom, we demonstrate that retail investors prefer a concentrated index provision market with index providers commanding substantial market power over passive funds.

Keywords: Index construction, Index providers, Passive investing, Benchmark regulation

JEL Classification: G11, G23, L10