Active Investing and the Efficiency of Security Markets

Abstract

This study investigates the impact of active investment management on the efficiency of public security markets. The scholarly literature indicates that active management contributes to market efficiency, thereby providing positive externalities for all investors, including investors in passively-managed funds. Contrary to popular interpretations of Sharpe’s (1991) “active arithmetic,” the benefits of active management are amplified in small- and mid-capitalization U.S. stocks, enhancing the ability of these companies to raise capital for investments in the real economy. Across all public corporations, the improved efficiency afforded by active management helps to discipline capital expenditures by corporations through a more efficient stock price.

Keywords: active management, index funds, passive management, market efficiency

JEL Classification: G23, G14