The Growth of Index Funds and the Pricing of Equity Securities

Abstract

The authors examine the hypothesis that the popularity of indexing to the S&P 500 had a self–fulfilling effect of inflating the prices of the stocks in the index during the 1990s. They conclude instead that the success of indexing results from the general efficiency of U.S. stock markets, and that the gap between the performance of index funds and active managers can be explained fully by the extra management and transaction costs involved in active management. The authors find no evidence that the success of indexing is self–fulfilling; nor can they substantiate that indexing has any permanent effect on the pricing of securities.