The Indexing Paradox -- Be Thankful for Irrational Investors
AbstractThis paper introduces the indexing paradox, which states that it if all investors are rational with rational expectations and have a common risk-averse investment performance measure, then no investor can expect to do better than the market. If the cost of indexing is less than the cost of active investing, then all investors would index, which would result with no mechanism to price the possible investments. This paradox relies merely on understanding averages. It does not rely on markets being “informationally efficient,” as demonstrated in a model where different investors have differing degrees of informational advantages and disadvantages.
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Bibliographic InfoPaper provided by EconWPA in its series Finance with number 0512034.
Date of creation: 30 Dec 2005
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index funds; indexing paradox;
Find related papers by JEL classification:
- G - Financial Economics
This paper has been announced in the following NEP Reports:
- NEP-ALL-2006-01-24 (All new papers)
- NEP-CFN-2006-01-24 (Corporate Finance)
- NEP-FMK-2006-01-24 (Financial Markets)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Ross M. Miller, 2005. "Measuring the True Cost of Active Management by Mutual Funds," Finance 0506010, EconWPA, revised 08 Jul 2005.
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- Sanford J Grossman & Joseph E Stiglitz, 1997. "On the Impossibility of Informationally Efficient Markets," Levine's Working Paper Archive 1908, David K. Levine.
- Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
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