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Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds

47 Pages Posted: 17 Jul 2006  

James J. Choi

Yale School of Management; National Bureau of Economic Research (NBER)

David Laibson

Harvard University - Department of Economics; National Bureau of Economic Research (NBER)

Brigitte C. Madrian

Harvard University - Harvard Kennedy School (HKS); National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: May 2006

Abstract

Experimental subjects allocate $10,000 across four S&P 500 index funds. Subject rewards depend on the chosen portfolio's subsequent return. Because the investments are not actually intermediated by the fund companies, portfolio returns are unbundled from non-portfolio services. The optimal portfolio therefore invests 100% in the lowest-cost fund. Nonetheless, subjects overwhelmingly fail to minimize fees. When we make fees transparent and salient, portfolios shift towards cheaper funds, but fees are still not minimized. Instead, subjects place high weight on normatively irrelevant historical returns. Subjects who choose high-cost index funds are relatively much less confident about their asset allocation choices.

Suggested Citation

Choi, James J. and Laibson, David and Madrian, Brigitte C., Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds (May 2006). NBER Working Paper No. w12261. Available at SSRN: https://ssrn.com/abstract=905518

James J. Choi (Contact Author)

Yale School of Management ( email )

135 Prospect Street
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National Bureau of Economic Research (NBER) ( email )

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David I. Laibson

Harvard University - Department of Economics ( email )

Littauer Center
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National Bureau of Economic Research (NBER) ( email )

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Brigitte C. Madrian

Harvard University - Harvard Kennedy School (HKS) ( email )

79 John F. Kennedy Street
Cambridge, MA 02138
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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