Index funds buy stocks "blind" without regard to company fundamentals. Do their activities contribute to mispricing of securities? EFF: Index funds typically buy cap-weighted portfolios so they do not contribute to mispricing. KRF: We analyze a general version of this question in "Disagreement, Tastes, and Asset Pricing" (Journal of Financial Economics, 2007). Suppose index fund investors hold a passive market portfolio. Then from a pricing perspective they are sitting on the sideline. They are not overweighting or underweighting any securities, so they do not affect (relative) prices. As a result, it is hard to argue that they contribute to mispricing. (Read the full entry)
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