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The Indexing Paradox -- Be Thankful for Irrational Investors

  • David Eagle

    (Eastern Washington University)

This 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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File URL: http://econwpa.repec.org/eps/fin/papers/0512/0512034.pdf
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Paper provided by EconWPA in its series Finance with number 0512034.

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Date of creation: 30 Dec 2005
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Handle: RePEc:wpa:wuwpfi:0512034
Note: Type of Document - pdf
Contact details of provider: Web page: http://econwpa.repec.org

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  1. Carhart, Mark M, 1997. " On Persistence in Mutual Fund Performance," Journal of Finance, American Finance Association, vol. 52(1), pages 57-82, March.
  2. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
  3. 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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