Working Paper: NBER ID: w8654
Authors: Randall Morck; Fan Yang
Abstract: The efficient markets hypothesis implies that passive indexing should generate as high a return as active fund management. Indexing has been a very successful strategy. We document a large value premium in the average q ratios of firms in the S&P 500 index relative to the q ratios of other similar firms that appears in the mid 1980s and grows in step with the growth of indexing. Passive investment strategies that require the purchase of the particular 500 stocks in this index increase demand for those stocks and so push up their prices. In short, indexing induces downward sloping demand curves for stocks in the index. For reasons that are not fully clear, arbitrageurs apparently do not correct this overvaluation.
Keywords: No keywords provided
JEL Codes: G0
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| SP 500 membership (G24) | increased demand from passive investors (G19) |
| increased demand from passive investors (G19) | higher stock prices (G12) |
| SP 500 membership (G24) | value premium (D46) |
| value premium (D46) | higher market value for included firms (G32) |
| reverse causation (C22) | lower statistical significance (C29) |
| SP 500 membership (G24) | average Tobin's q ratios (L15) |