First Faculty Advisor
Second Faculty Advisor
passive investing; liquidity; comovement
Most investments into equity markets can be categorized into two general strategies: active investments and passive investments. These strategies impact equity markets in different ways. Over the past few decades, market participants have witnessed a radical shift from active management to passive management. This paper reviews how this shift impacts market dynamics generally, and liquidity and comovement effects, in particular. Robust statistical analysis of total passive domestic equity assets under management (AUM), individual security, and market index data demonstrates that dramatic increases in passive investment flows correlates with decreased broad market liquidity and increased security-index comovement for securities in the technology sector. Both liquidity loss and increased comovement can potentially impact the pricing efficiency of equity markets. These potential pricing inefficiencies that the statistical analysis points towards can allow active management to realize excess returns in the future. It also points to a possible cycle which, if identified, may also lead to excess returns.