New Developments in Long-Term Asset Management

Supported by the Norwegian Finance Initiative
Monika Piazzesi and Luis Viceira, Organizers
Third Annual Conference
New York, New York

May 3-4, 2018

Is Index Trading Benign?

Shmuel Baruch and Xiaodi Zhang point out that investors costlessly observe noisy signals that are readily available in their environment. Sources of these signals can be, for example, experience with the customer services of firms, enthusiasm about products of certain brands, or even noting how full retailersÂ’ parking lots are. Each of these signals can hardly be called informative. However, when all the signals in the economy are aggregated, valuable information emerges.

Other Conference Papers

The Endowment Model and Modern Portfolio Theory, Stephen G. Dimmock, Nanyang Neng Wang, and Jinqiang Yang

Skin or Skim? Inside Investment and Hedge Fund Performance, Arpit Gupta, and Kunal Sachdeva

Characteristics Are Covariances: A Unified Model of Risk and Return, Bryan T. Kelly, Seth Pruitt, and Yinan Su

Do Intermediaries Matter for Aggregate Asset Prices? Valentin Haddad, and Tyler Muir

Do Foreign Investors Improve Market Efficiency? Marcin Kacperczyk, Savitar Sundaresan, and Tianyu Wang

What Drives Anomaly Returns? Lars Lochstoer, and Paul Tetlock

Replicating Anomalies, Kewei Hou, Chen Xue, and Lu Zhang

< 2017 Conference Papers>
< 2016 Conference Papers>

The researchers develop a conditional Capital Asset Pricing Model (CAPM) in which some investors, called index investors, confine themselves to combinations of the market portfolio and the risk-free asset. Because these index investors do not trade individual securities, some private information does not make its way into prices. The trade of index investors only reflects their information about the market as a whole. For example, if an investor is bearish on "half" the stocks and bullish on the other half, then it follows the investor's sentiment about the market as a whole is neutral. It is impossible to trace back the sources of the investor's neutral sentiment about the market, and the consequence is that prices of individual assets become less efficient.

The researchers show, among other things, that as the fraction of index investors increases, the proportion of idiosyncratic risk to market risk increases, the correlation among asset prices increases, and the statistical fit (measured by R2) of the CAPM regression decreases. In the extreme case in which all investors are indexers, only information pertaining to the market as a whole is incorporated into prices.

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