Indexing and the Incorporation of Exogenous Information Shocks to Stock Prices
Savings increasingly flow to low-cost index funds, which simply buy and hold the stocks in a major index, such as the S&P 500. This study presents direct evidence that increased indexing impairs the flow of information into stock prices. Specifically, similar idiosyncratic foreign currency shocks move the idiosyncratic stock returns of firms sensitive to those […]
Randall Morck is Jarislowsky Distinguished Chair and Distinguished University Professor at the University of Alberta, and M. Deniz Yavuz is Hanna Rising Star Associate Professor at Purdue University Krannert School of Management. This post is based on their NBER working paper. Related research from the Program on Corporate Governance includes Index Funds and the Future of Corporate Governance: Theory, Evidence, and Policy by Lucian Bebchuk and Scott Hirst (discussed on the Forum here and here); The Specter of the Giant Three by Lucian Bebchuk and Scott Hirst (discussed on the Forum here); and The Limits of Portfolio Primacy (discussed on the Forum here) by Roberto Tallarita.
Savings increasingly flow to low-cost index funds, which simply buy and hold the stocks in a major index, such as the S&P 500. This study presents direct evidence that increased indexing impairs the flow of information into stock prices. Specifically, similar idiosyncratic foreign currency shocks move the idiosyncratic stock returns of firms sensitive to those currencies 60% less when the firm is in the S&P 500 index than in proximate times when it is not in the index. We rely on currency shocks only because they are relatively simple to measure and quantify, so our findings suggest information flow impairment in general.
