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Border security in the age of globalization : How can we protect ourselves without losing the benefits of openness ?
| Content Provider | Semantic Scholar |
|---|---|
| Author | Alexanian, Nubar |
| Copyright Year | 2004 |
| Abstract | the safest path to stock market success, investors have often been told, is to diversify—to invest in different stocks representing the whole market. But by so often choosing index funds, perhaps we are heeding that advice too well. Unlike typical mutual funds, index funds invest in all the components of a stock index (the Dow Jones Industrials or the S&P 500, for example) and thereby closely duplicate the index’s returns. Because of their inherent diversification and low administrative costs, index funds have skyrocketed in popularity since their 1976 debut. But a recent study by Randall Morck and Fan Yang finds that stocks included in market indexes may be overvalued relative to similar excluded stocks. Index membership increases the demand for stocks in the index as fund managers and diversity-seeking investors buy more shares. Since the number of shares issued is relatively fixed, the prices of stocks in the index go up. Worse, Morck and Yang fear that the popularity of index funds caused an “indexing bubble” mirroring the “tech bubble” of the late 1990s. More than just an overvaluation, a bubble could occur if investors bought index-included stocks as much for their perceived propensity to continue increasing as for their underlying value. As the stock prices of firms included in the index increase, demand for those stocks rises, further increasing their price. The authors conclude that in 2001, the values of stocks included in the S&P 500 were as much as 90 percent above those for similarly sized companies not included in the index—a premium far in excess of what would be considered merely “overvalued.” Normally, investors sell overvalued stocks and buy their undervalued peers, eventually bringing prices back into line. But the popularity of index funds has made this almost impossible. Index funds are still attracting investors even as stock market investment overall has declined in the last three years. As a result, the premium on index funds, though diminished, has persisted. Morck and Yang point out, however, that if investors found alternative ways of diversifying and indexing became less popular, then the prices of a number of prominent stocks could fall sharply. Until then, the prices of indexed stocks will likely continue to command a premium. —Matt Rutledge perspective |
| File Format | PDF HTM / HTML |
| Alternate Webpage(s) | https://www.bostonfed.org/-/media/Documents/nerr/q303perspective.pdf |
| Language | English |
| Access Restriction | Open |
| Content Type | Text |
| Resource Type | Article |
