The Indexing Paradox -- Be Thankful for Irrational Investors

David Eagle ()

Finance from EconWPA

Abstract: 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.

Keywords: index funds; indexing paradox (search for similar items in EconPapers)
JEL-codes: G (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-cfn and nep-fmk
Date: 2005-12-30
Note: Type of Document - pdf
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Persistent link: http://EconPapers.repec.org/RePEc:wpa:wuwpfi:0512034

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