The Distortion in Prices Due to Passive Investing

Shmuel Baruch and Xiaodi Zhang ()
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Xiaodi Zhang: School of Finance, Shanghai University of Finance and Economics, Shanghai 200433, China

Management Science, 2022, vol. 68, issue 8, 6219-6234

Abstract: In the capital asset pricing model (CAPM), it is ex post optimal to index. To examine the implications of market indexing, we develop a conditional CAPM with costless private information in which some investors are, for exogenous reasons, ex ante indexers. We show that, as more nonindexers become indexers, the price efficiency of stocks diminishes, asset prices comove, and the statistical fit (measured by R 2 ) of the CAPM regression decreases. We also report asset prices at the limit, when 100% of the investors are market indexers.

Keywords: partially revealing rational expectation equilibrium; conditional CAPM; market indexing; comovement; R 2; 100% indexing (search for similar items in EconPapers)
Date: 2022
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Citations: View citations in EconPapers (1)

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Persistent link: https://EconPapers.repec.org/RePEc:inm:ormnsc:v:68:y:2022:i:8:p:6219-6234

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