How Competitive is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing

59 Pages Posted: 7 Apr 2021 Last revised: 15 Aug 2022

See all articles by Valentin Haddad

Valentin Haddad

University of California, Los Angeles (UCLA) - Anderson School of Management; National Bureau of Economic Research (NBER)

Paul Huebner

University of California, Los Angeles (UCLA) - Anderson School of Management

Erik Loualiche

University of Minnesota, Finance

Date Written: April 7, 2021

Abstract

We develop a framework to theoretically and empirically analyze how investors compete with each other in financial markets. In the classic view that markets are fiercely competitive, if a group of investors changes its behavior, other investors adjust their strategies such that nothing happens to prices. We propose a demand system with a flexible degree of strategic response and estimate it for institutional investors in the U.S. stock market. Investors react to the behavior of others in the market: when less aggressive traders surround an investor, she trades more aggressively. However, this strategic reaction is not nearly as strong as the classic view. Our estimates suggest that when a group of investors changes its behavior, the response of other investors only counteracts half of the direct impact. This result implies that the rise in passive investing over the last 20 years has led to substantially more inelastic aggregate demand curves for individual stocks by about 15%.

Keywords: Asset pricing model, Demand system, Institutional investors, Liquidity, Information, Portfolio choice

JEL Classification: G1, G2, D4, L1

Suggested Citation

Haddad, Valentin and Huebner, Paul and Loualiche, Erik, How Competitive is the Stock Market? Theory, Evidence from Portfolios, and Implications for the Rise of Passive Investing (April 7, 2021). Available at SSRN: https://ssrn.com/abstract=3821263 or http://dx.doi.org/10.2139/ssrn.3821263

Valentin Haddad

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Paul Huebner

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

Los Angeles, CA
United States

Erik Loualiche (Contact Author)

University of Minnesota, Finance ( email )

110 Wulling Hall, 86 Pleasant St, S.E.
308 Harvard Street SE
Minneapolis, MN 55455
United States
612 625 5679 (Phone)

HOME PAGE: http://https://loualiche.gitlab.io/www/

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
2,336
Abstract Views
7,471
Rank
10,158
PlumX Metrics