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Why falling information costs may increase demand for index funds

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  • Espen Sirnes

Abstract

Falling information costs may give the perverse incentive to buy less information in equilibrium. Using a model similar to Admati and Pfleiderer (1988) but with a market that clears via an equilibrium condition, it is shown that passive investment may actually rise with lower information costs. This is consistent with the empirical observation that index investing has increased along with a decline in information costs. Also, in absence of such costs, no investor will hold index portfolios if at least some uninformed investors can condition on current prices. The existence of passive index investors may therefore be inconsistent with unrestricted observation of current prices.

Suggested Citation

  • Espen Sirnes, 2011. "Why falling information costs may increase demand for index funds," Review of Financial Economics, John Wiley & Sons, vol. 20(1), pages 37-47, January.
    • Handle: RePEc:wly:revfec:v:20:y:2011:i:1:p:37-47
    DOI: 10.1016/j.rfe.2010.12.001
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    1. Stotz, Olaf & Georgi, Dominik, 2012. "A logit model of retail investors' individual trading decisions and their relations to insider trades," Review of Financial Economics, Elsevier, vol. 21(4), pages 159-167.

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