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Why falling information costs may increase demand for index funds

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  • Sirnes, Espen

Abstract

Falling information costs may give the perverse incentive to buy less information in equilibrium. Using a model similar to Admati and Pfleiderer (1988) but with a market that clears via an equilibrium condition, it is shown that passive investment may actually rise with lower information costs. This is consistent with the empirical observation that index investing has increased along with a decline in information costs. Also, in absence of such costs, no investor will hold index portfolios if at least some uninformed investors can condition on current prices. The existence of passive index investors may therefore be inconsistent with unrestricted observation of current prices.

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Bibliographic Info

Article provided by Elsevier in its journal Review of Financial Economics.

Volume (Year): 20 (2011)
Issue (Month): 1 (January)
Pages: 37-47

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Handle: RePEc:eee:revfin:v:20:y:2011:i:1:p:37-47

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Web page: http://www.elsevier.com/locate/inca/620170

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Keywords: Finance Asset pricing Information;

References

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  1. Foucault, Thierry & Cespa, Giovanni, 2008. "Insiders-outsiders, transparency and the value of the ticker," Les Cahiers de Recherche 892, HEC Paris.
  2. Wang, Jiang, 1959- & He, Hua., 1994. "Differential information and dynamic behavior of stock trading volume," Working papers 3731-94., Massachusetts Institute of Technology (MIT), Sloan School of Management.
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  4. Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
  5. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
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  7. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  8. Vives, X., 1993. "Short-Term Investment and the Informational Efficiency of the Market," UFAE and IAE Working Papers 207.93, Unitat de Fonaments de l'Anàlisi Econòmica (UAB) and Institut d'Anàlisi Econòmica (CSIC).
  9. Subrahmanyam, Avanidhar, 1991. "A Theory of Trading in Stock Index Futures," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 17-51.
  10. Goriaev, Alexei & Nijman, Theo E. & Werker, Bas J.M., 2008. "Performance information dissemination in the mutual fund industry," Journal of Financial Markets, Elsevier, vol. 11(2), pages 144-159, May.
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  12. Anat R. Admati, Paul Pfleiderer, 1988. "A Theory of Intraday Patterns: Volume and Price Variability," Review of Financial Studies, Society for Financial Studies, vol. 1(1), pages 3-40.
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Cited by:
  1. Stotz, Olaf & Georgi, Dominik, 2012. "A logit model of retail investors' individual trading decisions and their relations to insider trades," Review of Financial Economics, Elsevier, vol. 21(4), pages 159-167.

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