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

  • Choi, James
  • Madrian, Brigitte
  • Laibson, David I.

We evaluate why individuals invest in high-fee index funds. In our experiments, subjects each allocate $10,000 across four S&P 500 index funds and are rewarded for their portfolio’s subsequent return. Subjects overwhelmingly fail to minimize fees. We reject the hypothesis that subjects buy high-fee index funds because of bundled non-portfolio services. Search costs for fees matter, but even when we eliminate these costs, fees are not minimized. Instead, subjects place high weight on annualized returns since inception. Fees paid decrease with financial literacy. Interestingly, subjects who choose high-fee funds sense they are making a mistake.

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File URL: http://dash.harvard.edu/bitstream/handle/1/4686775/Laibson_OnePriceFail.pdf
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Paper provided by Harvard University Department of Economics in its series Scholarly Articles with number 4686775.

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Date of creation: 2010
Date of revision:
Publication status: Published in Review of Financial Studies
Handle: RePEc:hrv:faseco:4686775
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Web page: http://www.economics.harvard.edu/

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  17. Ippolito, Richard A, 1992. "Consumer Reaction to Measures of Poor Quality: Evidence from the Mutual Fund Industry," Journal of Law and Economics, University of Chicago Press, vol. 35(1), pages 45-70, April.
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  21. Xavier Gabaix & David Laibson & Hongyi Li, 2005. "Extreme Value Theory and the Effects of Competition on Profits," Levine's Bibliography 784828000000000656, UCLA Department of Economics.
  22. Hendricks, Darryll & Patel, Jayendu & Zeckhauser, Richard, 1993. " Hot Hands in Mutual Funds: Short-Run Persistence of Relative Performance, 1974-1988," Journal of Finance, American Finance Association, vol. 48(1), pages 93-130, March.
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