Finance: Function Matters, Not Size

26 Pages Posted: 3 Apr 2013

See all articles by John H. Cochrane

John H. Cochrane

Hoover Institution; National Bureau of Economic Research (NBER); University of Chicago - Booth School of Business

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Date Written: March 31, 2013

Abstract

I address the controversy over whether the financial services industry is “too big.” We should be asking whether the finance industry is functioning properly instead. The facts suggest that demand for financial services increased, perhaps temporarily, rather than suggesting a changing distortion within the industry. The puzzling persistence of actively managed mutual funds is finally yielding to supply and demand analysis, but the increasing preference for high-fee delegated management by sophisticated institutional investors remains somewhat of a puzzle. Conventional alpha-beta analysis does not capture the rich structure of risk premiums, which active management may be accessing. High-frequency information trading and the price-discovery process remain a puzzle as well. Many “inefficiencies” and events of the financial crisis suggest too little rather than too much active trading. The instability and regulation of the US financial system are more important issues than its mere size.

Suggested Citation

Cochrane, John H., Finance: Function Matters, Not Size (March 31, 2013). Available at SSRN: https://ssrn.com/abstract=2242705 or http://dx.doi.org/10.2139/ssrn.2242705

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