Asset pricing with index investing

Chabakauri, Georgy and Rytchkov, Oleg (2020) Asset pricing with index investing. Financial Markets Group Discussion Papers (806). Financial Markets Group, The London School of Economics and Political Science, London, UK.

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Abstract

We theoretically analyze how index investing affects financial markets using a dynamic exchange economy with heterogeneous investors and two Lucas trees. We identify two effects of indexing: lockstep trading of stocks increases market volatility and stock return correlations but reduction in risk sharing decreases them. Overall, indexing decreases market volatility but has an ambiguous effect on the correlations. Also, index investing decreases an investor's welfare, but indexing by other investors partially offsets the loss. When the introduction of index trading opens financial markets for new investors, the improved risk sharing makes market returns more volatile and stock returns more correlated.

Item Type:	Monograph (Discussion Paper)
Official URL:	https://www.fmg.ac.uk/
Additional Information:	© 2020 The Authors
Divisions:	Finance
Subjects:	H Social Sciences > HC Economic History and Conditions H Social Sciences > HG Finance
JEL classification:	G - Financial Economics > G1 - General Financial Markets > G12 - Asset Pricing; Trading volume; Bond Interest Rates D - Microeconomics > D5 - General Equilibrium and Disequilibrium > D52 - Incomplete Markets
Date Deposited:	23 May 2023 23:04
Last Modified:	16 May 2024 12:27
URI:	http://eprints.lse.ac.uk/id/eprint/118895

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