How Index Trading Increases Market Vulnerability

30 Pages Posted: 11 Aug 2011 Last revised: 1 Nov 2011

See all articles by Rodney N Sullivan

Rodney N Sullivan

University of Virginia, Darden Graduate School of Business

James X. Xiong

Morningstar Investment Management

Date Written: September 26, 2011

Abstract

Assets invested in passively managed equity mutual funds and exchange traded funds (ETFs) have grown steadily in recent years, reaching more than one trillion dollars at the end of 2010. Through a battery of tests, we establish that the rise in popularity of index investing contributes to higher systematic market risk. More indexed equity assets corresponds to increased cross-sectional trading commonality, in turn precipitating higher return correlations among stocks. We further discover that equity betas have not only risen but converged in recent years; also consistent with the accelerating growth and importance of passive investing.

Keywords: market risk, risk management

Suggested Citation

Sullivan, Rodney N and Xiong, James X., How Index Trading Increases Market Vulnerability (September 26, 2011). Financial Analysts Journal, Forthcoming. Available at SSRN: https://ssrn.com/abstract=1908227

Rodney N Sullivan (Contact Author)

University of Virginia, Darden Graduate School of Business ( email )

P.O. Box 6550
Charlottesville, VA 22906-6550
United States
434-243-0644 (Phone)

James X. Xiong

Morningstar Investment Management ( email )

22 W Washington
Chicago, IL 60602
United States

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