Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds

James J. Choi, David Laibson, Brigitte C. Madrian

NBER Working Paper No. 12261
Issued in May 2006, Revised in April 2008
NBER Program(s):Asset Pricing

Experimental subjects allocate $10,000 across four S&P 500 index funds. Subject rewards depend on the chosen portfolio's subsequent return. Because the investments are not actually intermediated by the fund companies, portfolio returns are unbundled from non-portfolio services. The optimal portfolio therefore invests 100% in the lowest-cost fund. Nonetheless, subjects overwhelmingly fail to minimize fees. When we make fees transparent and salient, portfolios shift towards cheaper funds, but fees are still not minimized. Instead, subjects place high weight on normatively irrelevant historical returns. Subjects who choose high-cost index funds are relatively much less confident about their asset allocation choices.

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Document Object Identifier (DOI): 10.3386/w12261

Published: Choi, James J., David Laibson, and Brigitte C. Madrian. “Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds." Review of Financial Studies 23, 4 (April 2010): 1405-1432. citation courtesy of

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