The Growth of Index Investing & Financial Markets

Abstract

Has the growth of index investing contributed to distortions in equity markets? Over the past eight years, assets under management in index-linked investments has increased five-fold. I study the link between capital flows into index-linked vehicles on three characteristics—price levels, comovement, and liquidity—of equity securities within the underlying index and out-of-index peers. Within the S&P 500 index, I find limited evidence of index-driven changes to these three characteristics. Of the effects that I do find—including changes in security comovement and liquidity characteristics upon index inclusion and deletion—I observe minimal changes in magnitude even as index-linked assets under management have dramatically increased.