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

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  • James J Choi
  • David Laibson
  • Brigitte C Madrian

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.

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Paper provided by David K. Levine in its series Levine's Working Paper Archive with number 122247000000002014.

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Date of creation: 21 Mar 2008
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Handle: RePEc:cla:levarc:122247000000002014

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