Indexing and the Incorporation of Exogenous Information Shocks to Stock Prices
Savings increasingly flow to low-cost index funds, which simply buy and hold the stocks in a major index, such as the S&P 500. Increased indexing impedes incorporation of idiosyncratic information into stock prices. We limit endogeneity bias by showing that exogenous idiosyncratic currency shocks induce smaller idiosyncratic moves in the stock prices of currency-sensitive firms in proximate time windows when in the index than when not in it. Increased indexing thus appears to be undermining the efficient markets hypothesis that supports its viability.