On the Economic Consequences of Index-Linked Investing
Trillions of dollars are invested through index funds, exchange-traded funds, and other index derivatives. The benefits of index-linked investing are well-known, but the possible broader economic consequences are unstudied. I review research which suggests that index-linked investing is distorting stock prices and risk-return tradeoffs, which in turn may be distorting corporate investment and financing decisions, investor portfolio allocation decisions, fund manager skill assessments, and other choices and measures. These effects may intensify as index-linked investing continues to grow in popularity.
I am grateful for helpful comments by Malcolm Baker, John Campbell, Ned Elton, Steve Figlewski, Martin Gruber, Antti Petajisto, William Silber, and Robert Whitelaw. I am also grateful to Randall Morck and Fan Yang for permission to reproduce Figure 3. The views expressed herein are those of the author and do not necessarily reflect the views of the National Bureau of Economic Research.
“On the Economic Consequences of Index - Linked Investing,” Challenges to Business in the Twenty - First Century: The Way Forward , edited by W.T. Allen, R. Khurana, J. Lorsch, and G. Rosenfeld, American Academy of Arts and Sciences, 2011.