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Asset pricing with index investing

Author

Listed:
  • Chabakauri, Georgy
  • Rytchkov, Oleg

Abstract

We provide a novel theoretical analysis of how index investing affects capital market equilibrium. We consider a dynamic exchange economy with heterogeneous investors and two Lucas trees and find that indexing can either increase or decrease the correlation between stock returns and in general increases (decreases) volatilities and betas of stocks with larger (smaller) market capitalizations. Indexing also decreases market volatility and interest rates, although those effects are weak. The impact of index investing is particularly strong when stocks have heterogeneous fundamentals. Our results highlight that indexing changes not only how investors can trade but also their incentives to trade.

Suggested Citation

  • Chabakauri, Georgy & Rytchkov, Oleg, 2014. "Asset pricing with index investing," LSE Research Online Documents on Economics 60739, London School of Economics and Political Science, LSE Library.
    • Handle: RePEc:ehl:lserod:60739
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    File URL: http://eprints.lse.ac.uk/60739/
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    References listed on IDEAS

    as
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    More about this item

    Keywords

    asset pricing; indexing; heterogeneous investors; Lucas trees;
    All these keywords.

    JEL classification:

    • D52 - Microeconomics - - General Equilibrium and Disequilibrium - - - Incomplete Markets
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates

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