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Why Does the Law of One Price Fail? An Experiment on Index Mutual Funds

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2010

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10.1093/rfs/hhp097

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Oxford University Press
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Choi, James, David Laibson, and Brigitte Madrian. 2010. Why does the law of one price fail? An experiment on index mutual funds. Review of Financial Studies 23(4): 1405-1432.

Abstract

We evaluate why individuals invest in high-fee index funds. In our experiments, subjects each allocate $10,000 across four S&P 500 index funds and are rewarded for their portfolio’s subsequent return. Subjects overwhelmingly fail to minimize fees. We reject the hypothesis that subjects buy high-fee index funds because of bundled non-portfolio services. Search costs for fees matter, but even when we eliminate these costs, fees are not minimized. Instead, subjects place high weight on annualized returns since inception. Fees paid decrease with financial literacy. Interestingly, subjects who choose high-fee funds sense they are making a mistake.

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This article is made available under the terms and conditions applicable to Open Access Policy Articles (OAP), as set forth at Terms of Service

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http://nrs.harvard.edu/urn-3:HUL.InstRepos:4686775

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Why Does the Law of One… : DASH Story 2015-11-26
I read about this study in the press, but reading the original paper was so much more informative. I'm a graduate student, with no budget for purchasing research, so without Open Access, I would not have had access to this. I'm studying the mutual fund industry and this paper, Why Does the Law of One Price Fail?, really breaks new ground, in my opinion. So thank you so much for making it available!
Story
Why Does the Law of One… : DASH Story 2016-02-26
I read the results of this study back when it was first published and it was one of the reasons that I left industry to become a teacher. I wanted to help make personal finance a required class in high schools. Having access to it now serves as a reference to the facts for my students about why it is important to learn about how to choose a mutual fund, a topic that many high school students have trouble caring about. It also serves as a discussion piece for colleagues. I have designed a simplified version of the experiment to do as an activity in the class. It is not a required topic for the county, but the article points out the importance of it, which gives me justification for teaching it and gives the other teachers on my team a reason to consider doing so. Thank you.