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The Distortion in Prices Due to Passive Investing

Author

Listed:
  • Shmuel Baruch

    (Department of Economics and Finance, University of Rome Tor Vergata, Rome 00133, Italy)

  • Xiaodi Zhang

    (School of Finance, Shanghai University of Finance and Economics, Shanghai 200433, China)

Abstract

In the capital asset pricing model (CAPM), it is ex post optimal to index. To examine the implications of market indexing, we develop a conditional CAPM with costless private information in which some investors are, for exogenous reasons, ex ante indexers. We show that, as more nonindexers become indexers, the price efficiency of stocks diminishes, asset prices comove, and the statistical fit (measured by R 2 ) of the CAPM regression decreases. We also report asset prices at the limit, when 100% of the investors are market indexers.

Suggested Citation

  • Shmuel Baruch & Xiaodi Zhang, 2022. "The Distortion in Prices Due to Passive Investing," Management Science, INFORMS, vol. 68(8), pages 6219-6234, August.
    • Handle: RePEc:inm:ormnsc:v:68:y:2022:i:8:p:6219-6234
    DOI: 10.1287/mnsc.2021.4114
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    References listed on IDEAS

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