The Heterogeneous Effects of Passive Investing on Asset Markets

46 Pages Posted: 14 Jan 2020 Last revised: 19 Oct 2021

See all articles by Jonathan Brogaard

Jonathan Brogaard

University of Utah - David Eccles School of Business

Davidson Heath

University of Utah - David Eccles School of Business

Da Huang

University of Utah - David Eccles School of Business

Date Written: October 17, 2021

Abstract

This paper shows that passive funds systematically underweight or omit illiquid index assets. As a result, ETF trading activity consumes liquidity and reduces market quality for liquid assets, but has no effect on illiquid assets. Focusing on the unconditional average effect of passive investing and ignoring the passive funds' index deviations underestimates the local treatment effect by up to 58%. Overall, the effects of passive investing on asset markets depend on how intermediaries replicate their target index.

Keywords: exchange-traded funds, passive investment, index, replication strategy, market quality

JEL Classification: G11, G12, G20

Suggested Citation

Brogaard, Jonathan and Heath, Davidson and Huang, Da, The Heterogeneous Effects of Passive Investing on Asset Markets (October 17, 2021). Available at SSRN: https://ssrn.com/abstract=3510359 or http://dx.doi.org/10.2139/ssrn.3510359

Jonathan Brogaard

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

HOME PAGE: http://www.jonathanbrogaard.com

Davidson Heath (Contact Author)

University of Utah - David Eccles School of Business ( email )

1645 E Campus Center Dr
Salt Lake City, UT 84112-9303
United States

Da Huang

University of Utah - David Eccles School of Business ( email )

David Eccles School of Business
Salt Lake City, UT 84112
United States

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