Working Paper: NBER ID: w16376
Authors: Jeffrey Wurgler
Abstract: 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.
Keywords: Index-linked investing; Stock prices; Corporate investment; Economic consequences
JEL Codes: G10; G11; G12; G14; G20
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Index-linked investing (G23) | stock prices (G12) |
| stock prices (G12) | corporate investment decisions (G31) |
| Index-linked investing (G23) | corporate investment decisions (G31) |
| index inclusion (Y60) | perceived risk (D81) |
| perceived risk (D81) | corporate investment decisions (G31) |
| index price movements (E30) | further demand (R22) |
| further demand (R22) | price shocks (E30) |