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How Competitive is the Stock Market?
Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing
(with Valentin Haddad and Paul Huebner)


American Economic Review, March 2025

First version: April 2021
This version:  April 2024
Published:     March 2025

Download the paper
Download the online Appendix

AER's link

Replication package


Abstract:

The conventional wisdom in finance is that competition is fierce among investors: if a group
changes its behavior, others adjust their strategies such that nothing happens to prices.
We estimate a demand system with flexible strategic responses for institutional investors
in the US stock market. When less aggressive traders surround an investor, she adjusts
by trading more aggressively. However, this strategic reaction only counteracts two thirds
of the impact of the initial change in behavior. In light of these estimates, the rise in
passive investing over the last 20 years has made the demand for individual stocks
11% more inelastic.







Write up in Risk.net
  How hedge funds can be limited in fixing mispricings (paywall)
Write up in UCLA Anderson Review
  As Passive Investing Spreads, Overall Market Becomes Less Competitive
Valentin talks to Steve Johnson at the Financial Times
  Passive investing has increased US stock volatility, study finds
Lex's column
  How inelastic markets relates to the price of eggs (and vice-versa)?
Justin Lee in Bloomberg
  'Magical' Efficient Market Theory Rebuked in Era of Passive Investing (paywall)
Rational Reminder Podcast


Winner of the Q Group’s annual Jack Treynor Prize (2021)
Best Paper on Financial Institutions (Elsevier Sponsored Award; WFA 2022)


SSRN link



Useful datasets from the paper: 
  List of our passive investors classification for each quarter.
  List of our stock-level elasticity estimates for each quarter.


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