The Shift from Active to Passive and its Effect on Intraday Stock Dynamics

Abstract

Recent empirical studies argue that passive funds tend to propagate liquidity shocks to the underlying securities, thus increasing stock volatility. We document that the growing importance of the closing auction has caused trading in ETFs, much like trading in the underlying stocks, to shift significantly towards the Close. Motivated by this result, we use intraday data to analyse the relation between passive ownership and stock price dynamics. The main conclusion is that the effect is concentrated at the end of the continuous trading session and at the Close. This is arguably due to the concentration of portfolio trades in the order flow during that phase. We find that among US stocks, a two standard deviation increase in ETF ownership would generate a 2.99% relative increase in volatility for the median stock near the Close. In contrast, we find little evidence that prices of passively held securities are more volatile at the beginning of the trading session.

Keywords: Intraday stock dynamics, intraday volatility, market on close trading, active to passive shift, ETF ownership, passive ownership