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Are Investors Rational? Choices among Index Funds

In: Investments And Portfolio Performance

Author

Listed:
  • EDWIN J. ELTON

    (New York University, USA)

  • MARTIN J. GRUBER

    (New York University, USA)

  • JEFFREY A. BUSSE

    (Emory University, USA)

Abstract

S&P 500 index funds represent one of the simplest vehicles for examining rational behavior. They hold virtually the same securities, yet their returns differ by more than 2 percent per year. Although the relative returns of alternative S&P 500 funds are easily predictable, the relationship between cash flows and performance is weaker than rational behavior would lead us to expect. We show that selecting funds based on low expenses or high past returns outperforms the portfolio of index funds selected by investors. Our results exemplify the fact that, in a market where arbitrage is not possible, dominated products can prosper.

Suggested Citation

  • Edwin J. Elton & Martin J. Gruber & Jeffrey A. Busse, 2010. "Are Investors Rational? Choices among Index Funds," World Scientific Book Chapters, in: Edwin J Elton & Martin J Gruber (ed.), Investments And Portfolio Performance, chapter 8, pages 145-172, World Scientific Publishing Co. Pte. Ltd..
    • Handle: RePEc:wsi:wschap:9789814335409_0008
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