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STICERD Industrial Organisation Seminars

Why Do Investors Buy Expensive Index Funds? Quantifying Frictions in the Index Fund Market

Jihye Jeon (Boston University)

Monday 06 March 2023 12:30 - 14:00

Many of our seminars and public events this year will continue as in person or as hybrid (online and in person) events. Please check our website listings and Twitter feed @STICERD_LSE for updates.

Unless otherwise specified, in-person seminars are open to the public.

Those unable to join the seminars in-person are welcome to participate via zoom if the event is hybrid.

About this event

Index funds are one of the most common ways investors access equity markets and are perceived to be a transparent and low-cost alternative to active investment management. Despite these purported virtues of passive asset management, there still exists substantial price dispersion in the index fund market. Why do investors buy expensive index funds? We develop a novel quantitative dynamic model of demand for and supply of index funds. In the model investors are subject to inertia, information frictions, and have heterogeneous preferences. Our results suggest that the average expense ratios paid by retail investors are roughly 54% higher as a result of information frictions and are 20% higher as a result of inertia. Interestingly there is an interaction between these frictions. Inertia becomes much more costly for investors when information frictions are reduced. These frictions on the demand-side create market power for index fund providers, which providers exploit by price discriminating across consumers. We find that index fund providers' ability to price discriminate across retail and institutional investors increases the expense ratios that retail investors pay by 25%.

Industrial Organisation seminars are held on Mondays in term time at 12:30-14:00, in person in SAL 3.05, unless specified otherwise.

Seminar organiser: Alessandro Gavazza.

For further information please contact Sadia Ali:

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