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The Equilibrium Consequences of Indexing

Author

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  • Philip Bond
  • Diego García

Abstract

We develop a benchmark model to study the equilibrium consequences of indexing in a standard rational expectations setting. Individuals incur costs to participate in financial markets, and these costs are lower for individuals who restrict themselves to indexing. A decline in indexing costs directly increases the prevalence of indexing, thereby reducing the price efficiency of the index and augmenting relative price efficiency. In equilibrium, these changes in price efficiency in turn further increase indexing, and raise the welfare of uninformed traders. For well-informed traders, the share of trading gains stemming from market timing increases relative to stock selection trades.

Suggested Citation

  • Philip Bond & Diego García, 2022. "The Equilibrium Consequences of Indexing," The Review of Financial Studies, Society for Financial Studies, vol. 35(7), pages 3175-3230.
    • Handle: RePEc:oup:rfinst:v:35:y:2022:i:7:p:3175-3230.
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    File URL: http://hdl.handle.net/10.1093/rfs/hhab106
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    Cited by:

    1. Chinco, Alex & Sammon, Marco, 2024. "The passive ownership share is double what you think it is," Journal of Financial Economics, Elsevier, vol. 157(C).
    2. Ailie Charteris & Conrad Alexander Steyn, 2023. "The Bank of Japan’s exchange traded fund purchases: a help or hindrance to market efficiency?," Journal of Asset Management, Palgrave Macmillan, vol. 24(3), pages 225-240, May.

    More about this item

    Keywords

    D82; G14;

    JEL classification:

    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading

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