Index portfolio and welfare analysis under heterogeneous beliefs |
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| Institution: | 1. Haas School of Business, University of California, Berkeley, United States;2. School of Commerce, University of South Australia, Australia;3. School of Mathematics and Applied Statistics, University of Wollongong, Australia;4. University of South Australia;5. University of Calgary, Canada;6. Financial Engineering Division, Stevens Institute of Technology, Castle Point on Hudson, Hoboken, NJ 07030, United States;1. Department of Risk Management and Insurance, College of Economics, Shenzhen University, 3688 Nanhai Blvd., Nanshan District, Shenzhen 518060, Guangdong, China;2. Safeco Distinguished Professor of Insurance, Department of Finance and Management Science, Washington State University, PO Box 644746, Pullman, WA 99164-4746, USA;3. Department of Finance and Marketing, College of Business, California State University, Chico;1. Binghamton University, AA210, School of Management, Binghamton, NY 13902, US;2. University of Michigan Law School, 1039 Legal Research, Ann Arbor, Michigan 48109, US;1. Department of Quantitative Methods and Economic Theory, University of Alicante, San Vicente del Raspeig, Alicante 03080, Spain;2. Department of Economics and Finance, Manuel Moreno is from University of Castilla La-Mancha,Toledo 45071, Spain;1. University of Alabama at Birmingham, United States;2. California State University, Fullerton, United States;3. University of Mississippi, United States |
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| Abstract: | With a growing popularity of index funds, we adopt a differences-in-opinion, general equilibrium framework to examine theoretically whether investors are better off with an index portfolio than active investing. In contrary to the conventional view, we find that, even for an active investor with the most accurate belief, switching to an index portfolio can significantly improve his expected ex-post welfare when the active investors have incorrect beliefs or face incomplete information. Moreover, the welfare improvement becomes more substantial when the active investors are more risk averse. |
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