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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.

Suggested Citation

  • Sirnes, Espen, 2011. "Why falling information costs may increase demand for index funds," Review of Financial Economics, Elsevier, vol. 20(1), pages 37-47, January.
  • Handle: RePEc:eee:revfin:v:20:y:2011:i:1:p:37-47
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    References listed on IDEAS

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    1. Kenneth R. French, 2008. "Presidential Address: The Cost of Active Investing," Journal of Finance, American Finance Association, vol. 63(4), pages 1537-1573, August.
    2. 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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    8. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
    9. Vives, Xavier, 1995. "Short-Term Investment and the Informational Efficiency of the Market," Review of Financial Studies, Society for Financial Studies, vol. 8(1), pages 125-160.
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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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    Keywords

    Finance Asset pricing Information;

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