Title: The indexing paradox: be thankful for irrational analysts

Authors: David Eagle, Arsen M. Djatej, Robert H.S. Sarikas, David Senteney

Addresses: College of Business and Public Administration, Eastern Washington University, 668 N. Riverpoint Blvd., Suite A, Spokane, WA 99202-1660, USA. ' College of Business and Public Administration, Eastern Washington University, 668 N. Riverpoint Blvd., Suite A, Spokane, WA 99202-1660, USA. ' College of Business, Ohio University, Copeland Hall, Athens, Ohio 45701, USA. ' College of Business, Ohio University, Copeland Hall, Athens, Ohio 45701, USA

Abstract: This paper introduces the indexing paradox, which states that it if all investors are rational with rational expectations and have a common risk-averse investment performance measure, then no investor can expect to do better than the market. If the cost of indexing is less than the cost of active investing, then all investors would index, which would result with no mechanism to price the possible investments. This paradox relies merely on understanding averages. It does not rely on markets being ||informationally efficient||, as demonstrated in a model where different investors have differing degrees of informational advantages and disadvantages.

Keywords: indexing paradox; index funds; passive investing; active investing; risk-averse investment; performance measures; modelling.

DOI: 10.1504/IJMEF.2010.035598

International Journal of Monetary Economics and Finance, 2010 Vol.3 No.4, pp.374 - 393

Published online: 01 Oct 2010 *

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