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Tracking biased weights: asset pricing implications of value-weighted indexing

Jiang, Hao, Vayanos, Dimitri ORCID: 0000-0002-0944-4914 and Zheng, Lu (2020) Tracking biased weights: asset pricing implications of value-weighted indexing. Financial Markets Group Discussion Papers (823). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

We show theoretically and empirically that flows into index funds raise the prices of large stocks in the index disproportionately more than the prices of small stocks. Conversely, flows predict a high future return of the small-minus-large index portfolio. This finding runs counter to the CAPM, and arises when noise traders distort prices, biasing index weights. When funds tracking value-weighted indices experience inflows, they buy mainly stocks in high noise-trader demand, exacerbating the distortion. During our sample period 2000-2019, a small-minus-large portfolio of S&P500 stocks earns ten percent per year, while no size effect exists for non-index stocks.

Item Type: Monograph (Discussion Paper)
Official URL: https://www.fmg.ac.uk/
Additional Information: © 2020 The Authors
Divisions: Finance
Subjects: H Social Sciences > HG Finance
H Social Sciences > HC Economic History and Conditions
JEL classification: G - Financial Economics > G1 - General Financial Markets > G10 - General
G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice; Investment Decisions
G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates
G - Financial Economics > G2 - Financial Institutions and Services > G23 - Pension Funds; Other Private Financial Institutions
Date Deposited: 18 May 2023 07:54
Last Modified: 01 Apr 2024 07:59
URI: http://eprints.lse.ac.uk/id/eprint/118847

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